Description of Proposal

The proposal would provide that the gross income of a lessee does not include amounts
received in cash or treated as rent reductions from a lessor under a short-term lease of retail
space to the extent the allowance does not exceed the amount expended by the lessee on the
construction or improvement of qualified long-term real property. For this purpose, "qualified
long-term real property" would mean nonresidential real property that is part of, or otherwise
present at, retail space and that reverts to the lessor at the termination of the lease. A "short-term
lease" would mean a lease or other agreement for the occupancy or use of retail space for a term
of 15 years or less (as determined pursuant to sec. 168(i)(3)).

The lessor would treat the amounts expended on the construction allowance as
nonresidential real property and the proposal would contain reporting requirements to ensure that
both the lessor and lessee treat such amounts as nonresidential real property.

Effective Date
The proposal would apply to leases entered into after the date of enactment. No

inference would be intended as to the treatment of amounts received that are not subject to the
proposal.

-15-



ordinary course of a trade or business) other than foreclosure property. Thus, the 100 percent tax
on prohibited transactions helps to ensure that the REIT is a passive entity and may not engage
in ordinary retailing activities such as sales to customers of condominium units or subdivided

lots in a development project. A safe harbor is provided for certain sales that otherwise might be
considered prohibited transactions (sec. 857(b)(6)(C)). The safe harbor is limited to seven or
fewer sales a year or, alternatively, any number of sales provided that the aggregate adjusted
basis of the property sold does not exceed 10 percent of the aggregate basis of all the REIT’s
assets at the beginning of the REIT's taxable year.

Requirements for REIT Status

AREIT must satisfy four tests on a year-by-year basis: organizational structure, source of
income, nature of assets, and distribution of income. These tests are intended to allow conduit
treatment in circumstances in which a corporate tax otherwise would be imposed, only if there
Teally is a pooling of investment arrangement that is evidenced by its organizational structure, if
its investments are basically in-real estate assets, and if its income is passive income from real
estate investment, as contrasted with income from the operation of a business involving real
estate. In addition, substantially all of the entity's income must be passed through to its
shareholders on a current basis.

Organizational structure requirements

To qualify as a REIT, an entity must be for its entire taxable year a corporation or an
unincorporated trust or association that would be taxable as a domestic corporation but for the
REIT provisions, and must be managed by one or more trustees (sec. 856(a)). The beneficial
ownership of the entity must be evidenced by transferable shares or certificates of ownership.
Except for the first taxable year for which an entity elects to be a REIT, the beneficial ownership
of the entity must be held by 100 or more persons, and the entity may not be so closely held by
individuals that it would be treated as a personal holding company if all its adjusted gross
income constituted personal holding company income. A REIT is disqualified for any year in
which it does not comply with regulations to ascertain the actual ownership of the REIT's
outstanding shares.

‘Income requirements
Overview
In order for an entity to qualify as a REIT, at least 95 percent of its gross income
generally must be derived from certain passive sources (the "95-percent test"). In addition, at
least 75 percent of its income generally must be from certain real estate sources (the "75-percent

test"), including rents from real property.

In addition, less than 30 percent of the entity's gross income may be derived from gain
from the sale or other disposition of stock or securities held for less than one year, real property

-36-


Description of Proposal

The proposal would extend the time for the filing of an RAA relating to the deduction by
a partnership for a worthless security or bad debt. In these circumstances, in lieu of the
three-year period provided in section 6227(a)(1), the period for filing an RAA would be seven
years from the date the partnership return was due with respect to which the request is made
(determined without regard to extensions). The RAA would still be required to be filed before
the FPAA is mailed for the taxable year.

Effective Date

Effective as if included in the amendments made by section 402 of the Tax Equity and
Fiscal Responsibility Act of 1982.

-32-


could revoke an election to treat property as foreclosure property for any taxable year by filing a
revocation on or before its due date for filing its tax return.

In addition, the proposal would conform the definition of independent contractor for
purposes of the foreclosure property rule (sec. 856(e)(4)(C)) to the definition of independent
contractor for purposes of the general rules (sec. 856(d)(2)(C)).

Payments under hedging instruments

The proposal would treat income from all hedges that reduce the interest rate risk of
REIT liabilities, not just from interest rate swaps and caps, as qualifying income under the
95-percent test. Thus, payments to a REIT under an interest rate swap, cap agreement, option,
futures contract, forward rate agreement or any similar financial instrument entered into by the
REIT to hedge its indebtedness incurred or to be incurred (and any gain from the sale or other
disposition of these instruments) would be treated as qualifying income for purposes of the
95-percent test.

Excess noncash income

The proposal would (1) expand the class of excess noncash items to include income from
the cancellation of indebtedness and (2) extends the treatment of original issue discount and
coupon interest as excess noncash items to REITs that use an accrual method of taxation.

Prohibited transaction safe harbor

The proposal would exclude from the prohibited sales rules property that was
involuntarily converted.

Shared appreciation mortgages

The proposal would provide that interest received on a shared appreciation mortgage is
not subject to the tax on prohibited transactions where the property subject to the mortgage is
sold within 4 years of the REIT's acquisition of the mortgage pursuant to a bankruptcy plan of
the mortgagor unless the REIT acquired the mortgage knew or had reason to know that the
property subject to the mortgage would be sold in a bankruptcy proceeding.

Wholly-owned REIT subsidiaries

The proposal would permit any corporation wholly-owned by a REIT to be treated as a
qualified subsidiary, regardless of whether the corporation had always been owned by the REIT.
Where the REIT acquired an existing corporation, the proposal would treat any such corporation
as being liquidated as of the time of acquisition by the REIT and then reincorporated (thus, any
of the subsidiary's pre-REIT built-in gain would be subject to tax under the normal rules of

-41-



F. Payment of Taxes by Commercially Acceptable Means
Present Law

Payment of taxes may be made by checks or money orders, to the extent and under the
conditions provided by Treasury regulations (sec. 6311).

Description of Proposal

The proposal would allow the IRS to accept payment by any commercially acceptable
means that the Secretary deems appropriate, to the extent and under the conditions provided in
Treasury regulations. This would include, for example, electronic funds transfers, including
those arising from credit cards, debit cards, and charge cards.

The IRS contemplates that it will proceed to negotiate contracts to implement this
provision with one or more private sector credit and debit card systems. The proposal would
provide that the Federal Government will only pay any fees with respect to any such contracts
out of amounts specifically appropriated for that purpose.

The proposal would also exclude credit card, debit card, and charge card issuers and
processing mechanisms from the resolution of tax liability, but would make IRS subject to the
truth-in-lending provisions insofar as those provisions impose obligations and responsibilities
with regard to the “billing error” resolution process.

Effective Date
The proposal would be effective nine months after the date of enactment. The IRS could,

in this interim period, ‘conduct internal tests and negotiate with card issuers, but could not accept
credit or debit cards for payment of tax liability.

-9-



Effective Date

The provisions wouid be effective on the date of enactment.
3. Modify treatment of tires under the heavy highway vehicle retail excise tax
Present Law
A 12-percent retail excise tax is imposed on certain heavy highway trucks and trailers, and on
highway tractors. A separate manufacturers’ excise tax is imposed on tires weighing more than 40
pounds. This tire tax is imposed as a fixed dollar amount which varies based on the weight of the
tire. Because tires are taxed separately, the value of tires installed on a highway vehicle is excluded

from the 12-percent excise tax on heavy highway vehicles. The determination of value is factual and
has given rise to numerous tax audit challenges.

Description of Proposal

The current exclusion of the value of tires installed on a taxable highway vehicle would be
repealed. Instead, a credit for the amount of manufacturers’ excise tax actually paid on the tires
would be allowed.

Effective Date

The proposal would be effective after December 31, 1997.

-69-



Vil. ESTATE, GIFT, AND TRUST TAX SIMPLIFICATION
1. Eliminate gift tax filing requirements for gifts to charities

Present Law

A gift tax generally is imposed on lifetime transfers of property by gift (sec. 2501). In
computing the amount of taxable gifts made during a calendar year, a taxpayer generally may deduct
the amount of any gifts made to a charity (sec. 2522). Generally, this charitable gift deduction is
available for outright gifts to charity, as well as gifts of certain partial interests in property (such as a
remainder interest). A gift of a partial interest in property must be in a prescribed form in order to
qualify for the deduction.

Individuals who make gifts in excess of $10,000 to any one donee during the calendar year
generally are required to file a gift tax return (sec. 6019). This filing requirement applies to all gifts,
whether charitable or noncharitable, and whether or not the gift qualifies for a gift tax charitable
deduction. Thus, under current law, a gift tax return is required to be filed for gifts to charity in
excess of $10,000, even though no gift tax is payable on the transfer.

Description of Proposal

Gifts to charity would not be subject to the gift tax filing requirements of section 6019, as
long as the entire value of the transferred property qualifies for the gift tax charitable deduction under
section 2522. The filing requirements for gifts of partial interests in property would remain
unchanged.

Effective Date
The proposal would be effective for gifts made after the date of enactment.
2. Clarification of waiver of certain rights of recovery
Present Law

For estate and gift tax purposes, a marital deduction is allowed for qualified terminable
interest property (QTIP). Such property generally is included in the surviving spouse's gross estate
upon his or her death. The surviving spouse's estate is entitled to recover the portion of the estate tax
attributable to inclusion of QTIP from the person receiving the property, unless the spouse directs
otherwise by will (sec. 207A). For this purpose, a will provision specifying that all taxes shall be
paid by the estate is sufficient to waive the right of recovery.

A decedent's gross estate includes the value of previously transferred property in which the

decedent retains enjoyment or the right to income (sec. 2036). The estate is entitled to recover from
the person receiving the property a portion of the estate tax attributable to the inclusion (sec. 2207B).

-51-



F. Prohibition on Browsing
Present Law

The Internal Revenue Code prohibits disclosure of tax returns and return information,
except to the extent specifically authorized bythe Internal Revenue Code (sec. 6103).
Unauthorized willful disclosure is a felony punishable by a fine not exceeding $5,000 or
imprisonment of not more than five years, or both (sec. 7213). An action for civil damages also
may be brought for unauthorized disclosure (sec. 7431).

There is no explicit criminal penalty in the Internal Revenue Code for unauthorized
inspection (absent subsequent disclosure) of tax returns and return information. Such inspection
is, however, explicitly prohibited by the Internal Revenue Service ("IRS").'* Ina recent case, an
individual was convicted of violating the Federal wire fraud statute (18 U.S.C. 1343 and 1346)
and a Federal computer fraud statute (18 U.S.C. 1030) for unauthorized inspection. However,
the U.S. First Circuit Court of Appeals overturned this conviction.!* Unauthorized inspection of
information of any department or agency of the United States (including the IRS) via computer
was made a crime under 18 U.S.C. 1030 by the Economic Espionage Act of 1996."® This
provision does not apply to unauthorized inspection of paper documents.

Description of Proposal’”
Criminal penalties

The proposal would create a new criminal penalty in the Internal Revenue Code. The
penalty would be imposed for willful inspection (except as authorized by the Code) of any tax
return or return information by any Federal employee or IRS contractor. The penalty also would
apply to willful inspection (except as authorized) by any State employee or other person who
acquired the tax return or return information under specific provisions of section 6103. Upon
conviction, the penalty would be a fine in any amount not exceeding $1,000,'* or imprisonment
of not more than | year, or both, together with the costs of Prosecution. In addition, upon

*" IRS Declaration of Privacy Principles, May 9, 1994.
* US. v. Czubinski, DTR 2/25/97, p. K-2.
© PLL. 104-294, sec. 201 (October 11, 1996).

*” This proposal was passed by the House of Representatives and the Senate on April 15,
1997 (H.R. 1226).

** Pursuant to 18 U.S.C. sec. 3571 (added by the Sentencing Reform Act of 1984), the
amount of the fine is not more than the greater of the amount specified in this new Code section
or $100,000.

-49-



Description of Proposal

Any debt obligation the income from which would be eiigible for the exemption for
short-term OID under section 871(g)(1)(B)(i) if such income were received by the decedent on the
date of his death would be treated as property located outside of the United States in determining the
USS. estate tax liability of a nonresident not a U.S. citizen. No inference is intended with respect to
the estate tax treatment of such obligations under present law.

Effective Date

The proposal would be effective for estates of decedents dying after the date of enactment.
7. Certain revocable trusts treated as part of estate
Present Law

Both estates and revocable inter vivos trusts can function to settle the affairs of a decedent
and distribute assets to heirs. In the case of revocable inter vivos trusts, the grantor transfers property
into a trust which is revocable during his or her lifetime. Upon the grantor's death, the power to
revoke ceases and the trustee then performs the settlement functions typically performed by the
executor of an estate. While both estates and revocable trusts perform essentially the same function
after the testator or grantor’s death, there are a number of ways in which an estate and a revocable
trust operate differently. First, there can be only one estate per decedent while there can be more than
one revocable trust. Second, estates are in existence only for a reasonable period of administration;
revocable trusts can perform the same settlement functions as an estate, but may continue in
existence thereafter as testamentary trusts.

Numerous differences presently exist between the income tax treatment of estates and
revocable trusts, including: (1) estates are allowed a charitable deduction for amounts permanently
set aside for charitable purposes while post death revocable trusts are allowed a charitable deduction
only for amounts paid to charities; (2) the active participation requirement the passive loss rules
under section 469 is waived in the case of estates (but not revocable trusts) for two years after the
owner's death; and (3) estates can qualify for section 194 amortization of reforestation expenditures,
while trusts do not. :

Description of Proposal

The proposal would provide an irrevocable election to treat a qualified revocable trust as part
of the decedent's estate for Federal income tax purposes. This elective treatment would be effective
from the date of the decedent's death until two years after his or her death (if no estate tax return is
required) or, if later, six months after the final determination of estate tax liability (if an estate tax
return is required). The election must be made by both the executor of the decedent's estate (if any)
and the trustee of the revocable trust no later than the time required for filing the income tax return of

-55-



Under present law, pre-need funeral trusts generally are treated as grantor trusts, and the
annual income earned by such trusts is taxed to the purchaser/grantor of the trust. Rev. Rul. 87-127.
Any amount received from the trust by the seller (as payment for services or merchandise) is
includible in the gross income of the seller.

Description of Proposal

The trustee of a pre-need funeral trust would be allowed to elect special tax treatment for such
a trust, to the extent the trust would otherwise be treated as a grantor trust. A qualified funeral trust
would be defined as one which meets the following requirements: (1) the trust arises as the result of
a contract between a person engaged in the trade or business of providing funeral or burial services or
merchandise and one or more individuals to have such services or property provided upon such
individuals’ death; (2) the only beneficiaries of the trust are individuals who have entered into
contracts to have such services or merchandise provided upon their death; (3) the only contributions
to the trust are contributions by or for the benefit of the trust beneficiaries; (4) the trust's only purpose
is to hold and invest funds that will be used to make payments for funeral or burial services or
merchandise for the trust beneficiaries; and (5) the trust has not accepted contributions totaling more
than $7,000 by or for the benefit of any individual. For contracts entered into after 1998, the $7,000
limit would be indexed annually for inflation.

The trustee's election to have this provision apply to a qualified funeral trust would be made
separately with respect to each purchaser's trust. An electing trust would not be treated as a grantor
trust and the amount of tax paid with respect to each purchaser's trust would be determined in
accordance with the income tax rate schedule generally applicable to estates and trusts (Code sec.
1(e)), but no deduction would be allowed under section 642(b). The tax on the annual earnings of the
trust would be payable by the trustee.

Effective Date
The proposal would be effective for taxable years beginning after the date of enactment.
13. Adjustments for gifts within three years of decedent's death
Present Law

The first $10,000 of gifts of present interests to each donee during any one calendar year are
excluded from Federal gift tax.

The value of the gross estate includes the value of any previously transferred property if the
decedent retained the power to revoke the transfer (sec. 2038). The gross estate also includes the
value of any property with respect to which such power is relinquished during the three years before
death (sec. 2035). There has been significant litigation as to whether these rules require that certain
transfers made from a revocable trust within three years of death be includible in the gross estate.
See, e.g., Jalkut Estate v. Commissioner, 96 T.C. 675 (1991) (transfers from revocable trust

-59-



D. Clarify Statute of Limitations for Items from Pass-Through Entities

Present Law

Passthrough entities (such as S corporations, partnerships, and certain trusts) generally
are not subject to income tax on their taxable income. Instead, these entities file information
returns and the entities' shareholders (or beneficial owners) report their pro rata share of the
gross income and are liable for any taxes due.

Some believe that, prior to 1993, it may have been unclear as to whether the statute of
limitations for adjustments that arise from distributions from passthrough entities should be
applied at the entity or individual level (i.e., whether the 3-year statute of limitations for
assessments runs from the time that the entity files its information return or from the time that a
shareholder timely files his or her income tax return). In 1993, the Supreme Court held that the
limitations period for assessing the income tax liability of an S corporation shareholder runs
from the date the shareholder's return is filed (Bufferd v. Comm., 113 S. Ct. 927 (1993)).

Description of Proposal

The proposal would clarify that the return that starts the running of the statute of
limitations for a taxpayer is the return of the taxpayer and not the return of another person from
whom the taxpayer has received an item of income, gain, loss, deduction, or credit.

Effective Date

The proposal would be effective for taxable years beginning after the date of enactment.

-47-



The IRS may challeage the reporting position of a partnership by conducting a single
administrative proceeding to resolve the issue with respect to all partners. But the IRS must still
assess any resulting deficiency against each of the taxpayers who were partners in the year in
which the understatement of tax liability arose.

The IRS generally is required to give notice of the beginning of partnership-level
administrative proceedings and any resulting administrative adjustment to all partners whose
names and addresses are furnished to the IRS. For partnerships with more than 100 partners,
however, the IRS generally is not required to give notice to any partner whose profits interest is
less than one percent.

Description of Proposal

The proposal would create a new audit system for any partnership that is an electing large
partnership. The proposal would define "electing large partnership" as any partnership that
elects under the reporting provision, if the number of partners in the preceding partnership
taxable year is 100 or more.

As under present law, electing large partnerships and their partners would be subject to
unified audit rules. Thus, the tax treatment of "partnership items" would be determined at the
partnership, rather than the partner, level. The term "partnership items” would be defined as
under present law.

Unlike present law, however, partnership adjustments generally would flow through to
the partners for the year in which the adjustment takes effect. Thus, the current-year partners’
share of current-year partnership items of income, gains, losses, deductions, or credits would be
adjusted to reflect partnership adjustments that take effect in that year. The adjustments
generally would not affect prior-year returns of any partners (except in the case of changes to
any partner's distributive shares).

In lieu of flowing an adjustment through to its partners, the partnership may elect to pay
an imputed underpaymént. The imputed underpayment generally would be calculated by netting
the adjustments to the income and loss items of the partnership and multiplying that amount by
the highest tax rate (whether individual or corporate). A partner may not file a claim for credit
or refund of his allocable share of the payment. A partnership may make this election only if it
meets requirements set forth in Treasury regulations designed to ensure payment (for example, in
the case of a foreign partnership).

Effective Date

Partnership taxable years beginning after December 31, 1997.

-19-



held less than four years (other than foreclosure property, or property subject to an involuntary
conversion within the meaning of sec. 1033), and property that is sold or disposed of in a
prohibited transaction (sec. 856(c)(4)).

Definition of rents

For purposes of the income requirements, rents from real property generally include rents
from interests in real property, charges for services customarily rendered or furnished in
connection with the rental of real property, whether or not such charges are separately stated, and
rent attributable to personal property that is leased under or in connection with a lease of real
property, but only if the rent attributable to such personal property does not exceed 15 percent of
the total rent for the year under the lease (sec. 856(d)(1)).

Services provided to tenants are regarded as customary if, in the geographic market
within which the building is located, tenants in buildings that are of a similar class (for example,
luxury apartment buildings) are customarily provided with the service. The furnishing of water,
heat, light, and air conditioning, the cleaning of windows, public entrances, exits, and lobbies,
the performance of general maintenance, and of janitorial and cleaning services, the collection of
trash, the furnishing of elevator services, telephone answering services, incidental storage space,
laundry equipment, watchman or guard service, parking facilities and swimming pool facilities
are examples of services that are customarily furnished to tenants of a particular class of
buildings in many geographical marketing areas (Treas. reg. sec. 1.856-4(b)).

In addition, amounts are not treated as qualifying rent if received from certain parties in
which the REIT has an ownership interest of 10 percent or more (sec. 856(d)(2)(B)). For
purposes of determining the REIT's ownership interest in a tenant, the attribution rules of section
318 apply, except that 10 percent is substituted for 50 percent where it appears in subparagraph
(C) of section 318(a)(2) and 318(a)(3) (sec. 856(d)(5)).

Finally, where a REIT furnishes or renders services to the tenants of rented property,
amounts received or accrued with respect to such property generally are not treated as qualifying
rents unless the services are furnished through an independent contractor (sec. 856(d)(2)(C)). A
REIT may furnish or render a service directly, however, if the service would not generate
unrelated business taxable income under section 512(b)(3) if provided by an organization
described in section 511(a)(2). In general, an independent contractor is a person who does not
own more than a 35 percent interest in the REIT, and in which no more than a 35 percent interest
is held by persons with a 35 percent or greater interest in the REIT (sec. 856(d)(3)).

Hedging instruments

Interest rate swaps or cap agreements that protect a REIT from interest rate fluctuations
on variable rate debt incurred to acquire or carry real property are treated as securities under the
30-percent test and payments under these agreements are treated as qualifying under the
95-percent test (sec. 856(c)(6)(G)).

-37-



C. Other Excise Tax Provisions

1. Authority for Internal Revenue Service to grant exemptions from excise tax registration
requirements

Present Law

The Code exempts certain types of sales (e.g., sales for use in further manufacture, sales for
export, and sales for use by a State or local government or a nonprofit educational organization) from
excise taxes imposed on manufacturers and retailers. These exemptions generally apply only if the
seller, the purchaser, and any person to whom the article is resold by the purchaser (the second
purchaser) are registered with the Internal Revenue Service. The IRS can waive the registration
requirement for the purchaser and second purchaser in some but not all cases.

Description of Proposal

The IRS would be authorized to waive the registration requirement for purchasers and second
purchasers in all cases.

Effective Date

The proposal would apply to sales made pursuant to waivers issued after the date of
enactment.

2. Repeal of excise tax deadwood provisions
Present Law

The Code includes a provision relating to a temporary reduction in the tax on piggyback
trailers sold before July 18, 1985, and provisions relating to the tax on the removal of hard minerals
from the deep seabed before June 28, 1990,

An excise tax is imposed on the sale or use by the manufacturer or importer of certain ozone-
depleting chemicals (sec. 4681). The amount of the tax generally is determined by multiplying the
base tax amount applicable for the calendar year by an ozone-depleting factor assigned to each
taxable chemical. The base tax amount was $5.80 per pound in 1996 and will increase by 45 cents
per pound per year thereafter. The Code contains provisions for special rates of tax applicable to
years before 1996 (é.g., sec. 4282(g)(1), (2), (3), and (5)).

Description of Proposal

These provisions would be repealed, as deadwood.

~68-



C. Other Excise Tax Provisions
1.
2.
3.
D. Tax-Exempt Bond Provisions
1
2,
3.

4.

Authority for Internal Revenue Service to grant exemptions

from excise tax registration requirements ........... 00.00.00
Repeal of excise tax deadwood provisions ...................
Modify treatment of tires under the heavy highway vehicle

retail excise tax 26.0... eee

Repeal of $100,000 limitation on unspent proceeds under 1-year

exception from rebate ............

Exception from rebate for earnings on bona fide debt service

fund under construction bond mules ..

Repeal of debt service-based limitation on investment in

certain nonpurpose investments .....

Repeal of expired provisions relating to student loan bonds ......

E. Tax Court Procedures................

1,
2.
3.

4.

Overpayment determinations of Tax Court ...................

Redetermination of interest pursuant to motion . .

Application of net worth requirement for awards of litigation

Costs 2.6... eee

Tax Court jurisdiction for determination of employment status . . . .

F. Other Provisions ....................

Due date for first quarter estimated tax payments by private

foundations ................0...

Withholding of Puerto Rico income taxes from wages of

Federal employees ...............

Certain notices disregarded under provision increasing interest

rate on large corporate underpayments

9)

68
68

69

70

70

7

71
72

73

73
73

74
75

76

76

76

77


Effective Date
The proposal would apply to bonds issued after the date of enactment.

2. Exception from rebate for earnings on bona fide debt service fund under construction bond
rules

Present Law

In general, arbitrage profits from investing bond proceeds in investments unrelated to the
governmental purpose of the borrowing must be rebated to the Federal Government. An exception is
provided for certain construction bond issues if the bonds are governmental bonds, qualified
501(c)(3) bonds, or exempt-facility private activity bonds for governmentally-owned property.

This exception is satisfied only if the available construction proceeds of the issue are spent at
minimum specified rates during the 24-month period after the bonds are issued. The exception does
not apply to bond proceeds invested after the 24-month expenditure period as part of a reasonably
required reserve or replacement fund, a bona fide debt service fund, or to certain other investments
(e.g., sinking funds). Issuers of these construction bonds also may elect to comply with a penalty
regime in lieu of rebating arbitrage profits if they fail to satisfy the exception's spending
requirements.

Description of Proposal

The proposal would exempt earnings on bond proceeds invested in bona fide debt service
funds from the arbitrage rebate requirement and the penalty requirement of the 24-month exception if
the spending requirements of that exception are otherwise satisfied.

Effective Date
The proposal would apply to bonds issued after the date of enactment.
3. Repeal of debt service-based limitation on investment in certain nonpurpose investments
Present Law
Issuers of all tax-exempt bonds generally are subject to two sets of arbitrage restrictions on
investment of their bond proceeds. The first set requires that tax-exempt bond proceeds be invested at
a yield that is not materially higher (generally defined as 0.125 percentage points) than the bond
yield. Exceptions are provided to this restriction for investments during any of several "temporary

periods" pending use of the proceeds and, throughout the term of the issue, for proceeds invested as
part of a reasonably required reserve or replacement fund or a "minor" portion of the issue proceeds.

-71-



D. Tax-Exempt Bond Provisions
Overview

Interest on State and local government bonds generally is excluded from gross income for
purposes of the regular individual and corporate income taxes if the proceeds of the bonds are used to
finance direct activities of these governmental units (Code sec. 103).

Unlike the interest on governmental bonds, interest on private activity bonds generally is
taxable. A private activity bond is a bond issued by a State or local governmental unit acting as a
conduit to provide financing for private parties in a manner violating either (1) a private business use
and payment test or (2) a private loan restriction. However, interest on private activity bonds is not
taxable if (1) the financed activity is specified in the Code and (2) at least 95 percent of the net
proceeds of the bond issue is used to finance the specified activity.

. Issuers of State and local government bonds must satisfy numerous other requirements,
including arbitrage restrictions (for all such bonds) and annual State volume limitations (for most
private activity bonds) for the interest on these bonds to be excluded from gross income.

1. Repeal of $100,000 limitation on unspent proceeds under 1-year exception from rebate

Present Law

Subject to limited exceptions, arbitrage profits from investing bond proceeds in investments
unrelated to the governmental purpose of the borrowing must be rebated to the Federal Government.
No rebate is required if the gross proceeds of an issue are spent for the governmental purpose of the
borrowing within six months after issuance.

This six-month exception is deemed to be satisfied by issuers of governmental bonds (other
than tax and revenue anticipation notes) and qualified 501(c)(3) bonds if (1) all proceeds other than
an amount not exceeding the lesser of five percent or $100,000 are so spent within six months and (2)
the remaining proceeds are spent within one year after the bonds are issued.

Description of Proposal

The $100,000 limit on proceeds that may remain unspent after six months for certain
governmental and qualified 501(c)(3) bonds otherwise exempt from the rebate requirement would be
deleted. Thus, if at least 95 percent of the proceeds of these bonds is spent within six months after
their issuance, and the remainder is spent within one year, the six-month exception would be deemed
to be satisfied.

-70-



E. Tax Court Procedures
1, Overpayment determinations of Tax Court
Present Law

The Tax Court may order the refund of an overpayment determined by the Court, plus
interest, if the IRS fails to refund such overpayment and interest within 120 days after the Court's
decision becomes final. Whether such an order is appealable is uncertain.

In addition, it is unclear whether the Tax Court has jurisdiction over the validity or merits of
certain credits or offsets (e.g., providing for collection of student loans, child support, etc.) made by
the IRS that reduce or eliminate the refund to which the taxpayer was otherwise entitled.

Description of Proposal

The proposal would clarify that an order to refund an overpayment is appealable in the same
manner as a decision of the Tax Court. The proposal also would clarify that the Tax Court does not
have jurisdiction over the validity or merits of the credits or offsets that reduce or eliminate the
refund to which the taxpayer was otherwise entitled.

Effective Date
The proposal would be effective on the date of enactment.
2. Redetermination of interest pursuant to motion
Present Law

A taxpayer may seek a redetermination of interest after certain decisions of the Tax Court
have become final by filing a petition with the Tax Court.

It would be beneficial to taxpayers if a proceeding for a redetermination of interest
supplemented the original deficiency action brought by the taxpayer to redetermine the deficiency
determination of the IRS. A motion, rather than a petition, is a more appropriate pleading for relief in
these cases.

Description of Proposal

The proposal would provide that a taxpayer must file a "motion" (rather than a "petition") to
seek a redetermination of interest in the Tax Court.

-73-



Effective Date

Effective for partnership taxable years ending after the date of enactment.
10. Treatment of premature petitions filed by notice partners or 5-percent groups
Present Law

The Tax Matters Partner is given the exclusive right to file a petition for a readjustment
of partnership items within the 90-day period after the issuance of the notice of a final
partnership administrative adjustment (FPAA). If the Tax Matters Partner does not file a petition
within the 90-day period, certain other partners are permitted to file a petition within the 60-day
period after the close of the 90-day period. There are ordering rules for determining which
action goes forward and for dismissing other actions.

Description of Proposal

The proposal would treat premature petitions filed by certain partners within the 90-day
period as being filed on the last day of the following 60-day period under specified
circumstances, thus affording the partnership with an opportunity for judicial review that is not
available under present law.

Effective Date
Effective with respect to petitions filed after the date of enactment.
11. Bonds in case of appeals from certain proceedings
Present Law
A bond must be filed to stay the collection of deficiencies pending the appeal of the Tax

Court's decision ina TEFRA proceeding. The amount of the bond must be based on the court's
estimate of the aggregate deficiencies of the partners.

Description of Proposal

The proposal would clarify that the amount of the bond should be based on the Tax
Court's estimate of the aggregate liability of the parties to the action (and not all of the partners
in the partnership). For purposes of this proposal, the amount of the bond could be estimated by
applying the highest individual rate to the total adjustments determined by the Tax Court and
doubling that amount to take into account interest and penalties.

-30-


I. PARTNERSHIP SIMPLIFICATION PROVISIONS
A. General Provisions
1. Simplified flow-through for large partnerships
Present Law

A partnership generally is treated as a conduit for Federal income tax purposes. Each
partner takes into account separately his distributive share of the partnership's items of income,
gain, loss, deduction or credit. The character of an item is the same as if it had been directly
realized or incurred by the partner. Limitations affecting the computation of taxable income
generally apply at the partner level.

The taxable income of a partnership is computed in the same manner as that of an
individual, except that no deduction is permitted for personal exemptions, foreign taxes,
charitable contributions, net operating losses, certain itemized deductions, or depletion.
Elections affecting the computation of taxable income derived from a partnership are made by
the partnership, except for certain elections such as those relating to discharge of indebtedness
income and the foreign tax credit.

Taxpayers involved in the search for and extraction of crude oil and natural gas are
subject to certain special tax rules. As a result, in the case of partnerships engaged in such
activities, certain specific information is separately reported to partners.

Description of Proposal

The proposal would modify the tax treatment of an electing large partnership (generally,
any partnership that elects under the proposal, if the number of partners in the preceding
partnership taxable year is 100 or more) and its partners. The proposal would provide that each
partner takes into account separately the partner's distributive share of the following items,
which are determined at the partnership level: (1) taxable income or loss from passive loss
limitation activities; (2) taxable income or loss from other activities (e.g., portfolio income or
loss); (3) net capital gain or loss to the extent allocable to passive loss limitation activities and
other activities; (4) tax-exempt interest; (5) net alternative minimum tax adjustment separately
computed for passive loss limitation activities and other activities; (6) general credits; (7)
low-income housing credit; (8) rehabilitation credit; (9) credit for producing fuel from a
nonconventional source; (10) creditable foreign taxes and foreign source items; and (11) any
other items to the extent that the Secretary determines that separate treatment of such items is

-16-



B. Other Partnership Audit Rules
1. Treatment of partnership items in deficiency proceedings

Present Law

Partnership proceedings under rules enacted in TEFRA® must be kept separate from
deficiency proceedings involving the partners in their individual capacities. Prior to the Tax
Court's opinion in Munro v. Commissioner, 92 T.C. 71 (1989), the IRS computed deficiencies by
assuming that all items that were subject to the TEFRA partnership procedures were correctly
reported on the taxpayer's return. However, where the losses claimed from TEFRA partnerships
were so large that they offset any proposed adjustments to nonpartnership items, no deficiency
could arise from a non-TEFRA proceeding, and if the partnership losses were subsequently
disallowed in a partnership proceeding, the non-TEFRA adjustments might be uncollectible
because of the expiration of the statute of limitations with respect to nonpartnership items.

Faced with this situation in Munro, the IRS issued a notice of deficiency to the taxpayer
that presumptively disallowed the taxpayer's TEFRA partnership losses for computational
purposes only. Although the Tax Court ruled that a deficiency existed and that the court had
jurisdiction to hear the case, the court disapproved of the methodology used by the IRS to
compute the deficiency. Specifically, the court held that partnership items (whether income,
loss, deduction, or credit) included on a taxpayer's return must be completely ignored in
determining whether a deficiency exists that is attributable to nonpartnership items.

Description of Proposal

The proposal would overrule Munro and allow the IRS to return to its prior practice of
computing deficiencies by assuming that all TEFRA items whose treatment has not been finally
determined had been correctly reported on the taxpayer's return. This would eliminate the need
to do special computations that involve the removal of TEFRA items from a taxpayer's return,
and would restore to taxpayers a prepayment forum with respect to the TEFRA items. In
addition, the proposal would provide a special rule to address the factual situation presented in

Munro.

Specifically, the proposal would provide a declaratory judgment procedure in the Tax
Court for adjustments to an oversheltered return. An oversheltered return would be a return that
shows no taxable income and a net loss from TEFRA partnerships. In such a case, the IRS
would be authorized to issue a notice of adjustment with respect to non-TEFRA items,
notwithstanding that no deficiency would result from the adjustment. However, the IRS could

® Tax Equity and Fiscal Responsibility Act of 1982.

-22-


Commodity partnerships.--The election under these rules would not apply to any
partnership the principal activity of which is the buying and selling of commodities (not
described in sec. 1221(1)), or options, futures or forwards with respect to commodities.

Partnerships holding oil and gas properties. --In general, an electing large partnership that

is substantially engaged in oil and gas related activities would utilize the simplified reporting
regime, as modified for oil and gas purposes. A partnership would be considered to be
substantially engaged in oil and gas activities if at least 25 percent of the average value of its
assets during the taxable year consists of oil or gas properties.” In making this determination, a
partnership would be treated as owning its proportionate share of assets of any partnership in
which it holds an interest. The proposal would provide special rules for large partnerships with
oil and gas activities that operate under the simplified reporting regime (including electing large
partnerships that are not substantially engaged in oil and gas operations, but do have some oil
and gas activities).

Effective Date
Partnership taxable years beginning after December 3 1, 1997.

2. Simplified audit procedures for electing large partnerships

Present Law

The Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA") established unified
audit rules applicable to all but certain small (10 or fewer partners) partnerships. These rules
require the tax treatment of all "partnership items" to be determined at the partnership, rather
than the partner, level. Partnership items are those items that are more appropriately determined
at the partnership level than at the partner level, as provided by regulations.

Under the TEFRA rules, a partner must report all partnership items consistently with the
partnership return or must notify the IRS of any inconsistency. If a partner fails to report any
partnership item consistently with the partnership return, the IRS may make a computational
adjustment and immediately assess any additional tax that results.

Under the TEFRA rules, a partner must report all partnership items consistently with the
partnership return or must notify the IRS of any inconsistency. Ifa partner fails to report any
partnership item consistently with the partnership return, the IRS may make a computational
adjustment and immediately assess any additional tax that results.

” For this purpose, “oil or gas properties" means the mineral interests in oil or gas which are
of a character with respect to which a deduction for depletion is allowable under section 611.

-18-



Effective Date

Effective as if included in the amendments made by section 402 of the Tax Equity and
Fiscal Responsibility Act of 1982.

12. Suspension of interest where delay in computational adjustment resulting from certain
settlements

Present Law

Interest on a deficiency generally is suspended when a taxpayer executes a settlement
agreement with the IRS and waives the restrictions on assessments and collections, and the IRS
does not issue a notice and demand for payment of such deficiency within 30 days. Interest ona
deficiency that results from an adjustment of partnership items in TEFRA proceedings, however,
is not suspended.

Description of Proposal

The proposal would suspend interest where there is a delay in making a computational
adjustment relating to a TEFRA settlement.

Effective Date

Effective with respect to adjustments relating to taxable years beginning after the date of
enactment.

13. Special rules for administrative adjustment requests with respect to bad debts or
worthless securities ©

Present Law

The non-TEFRA statute of limitations for filing a claim for credit or refund generally is
the later of (1) three years from the date the return in question was filed or (2) two years from the
date the claimed tax was paid, whichever is later (sec. 6511(b)). However, an extended period of
time, seven years from the date the return was due, is provided for filing a claim for refund of an
overpayment resulting from a deduction for a worthless security or bad debt (sec. 6511(d)).

Under the TEFRA partnership rules, a request for administrative adjustment ("RAA")
must be filed within three years after the later of (1) the date the partnership return was filed or
(2) the due date of the partnership return (determined without regard to extensions) (sec.
6227(a)(1)). In addition, the request must be filed before a final partnership administrative
adjustment ("FPAA") is mailed for the taxable year (sec. 6227(a)(2)). There is no special
proposal for extending the time for filing an RAA that relates to a deduction for a worthless
security or an entirely worthless bad debt.

-31-



B. Minimum Tax Treatment of Certain Property and Casualty Insurance Companies

Present Law

Present law provides that certain property and casualty insurance companies may elect to
be taxed only on taxable investment income for regular tax purposes (sec. 831(b)). Eligible
property and casualty insurance companies are those whose net written premiums (or if greater,
direct written premiums) for the taxable year exceed $350,000 but do not exceed $1,200,000.

Under present law, all corporations including insurance companies are subject to an
alternative minimum tax. Alternative minimum taxable income is increased by 75 percent of the
excess of adjusted current earnings over alternative minimum taxable income (determined
without regard to this adjustment and without regard to net operating losses).

Description of Proposal

The proposal would provide that a property-and casualty insurance company that elects
for regular tax purposes to be taxed only on taxable investment income determines its adjusted
current earnings under the alternative minimum tax without regard to any amount not taken into
account in determining its gross investment income under section 834(b). Thus, adjusted current
earnings of an electing company would be determined without regard to underwriting income (or
underwriting expense, as provided in sec. 56(g)(4)(B)(i)(ID).

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997.

-13-



Except for temporary periods and amounts held pending use to pay current debt service,
present law also limits the amount of the proceeds of private activity bonds (other than qualified
501(c)(3) bonds) that may be invested at materially higher yields at any time during a bond year to
150 percent of the debt service for that bond year. This restriction affects primarily investments in
reasonably required reserve or replacement funds. Present law further restricts the amount of
proceeds from the sale of bonds that may be invested in these reserve funds to ten percent of such
proceeds. The second set of arbitrage restrictions requires generally that all arbitrage profits earned
on investments unrelated to the governmental purpose of the borrowing be rebated to the Federal
Government. Arbitrage profits include all earnings (in excess of bond yield) derived from the
investment of bond proceeds (and subsequent earnings on any such earnings).

Description of Proposal

The proposal would repeal the 150-percent of debt service yield restriction.
Effective Date
The proposal would apply to bonds issued after the date of enactment.
4, Repeal of expired provisions relating to student loan bonds

Present Law

Present law includes two special exceptions to the arbitrage rebate and pooled financing
temporary period rules for certain qualified student loan bonds. These exceptions applied only to
bonds issued before January 1, 1989.

Description of Proposal

These special exceptions would be repealed as "deadwood."
Effective Date

The proposal would apply to bonds issued after the date of enactment.

-72-



different shares of the trust's corpus.” Treasury regulations provide that "[t]he application of the
separate share rule . . . will generally depend upon whether distributions of the trust are to be made in
substantially the same manner as if separate trusts had been created. . . . Separate share treatment will
not be applied to a trust or portion of a trust subject to a power to distribute, apportion, or accumulate
income or distribute corpus to or for the use of one or more beneficiaries within a group or class of
beneficiaries, unless the payment of income, accumulated income, or corpus of a share of one
beneficiary cannot affect the proportionate share of income, accumulated income, or corpus of any
shares of the other beneficiaries, or unless substantially proper adjustment must thereafter be made
under the governing instrument so that substantially separate and independent shares exist." (Treas.
Reg. sec. 1.663(c)-3). The separate share rule presently does not apply to estates.

Description of Proposal

The proposal would extend the application of the separate share rule to estates. There would
be separate shares in an estate when the governing instrument of the estate creates separate economic
interests in one beneficiary or class of beneficiaries such that the economic interests of those
beneficiaries are not affected by economic interests accruing to another separate beneficiary or class
of beneficiaries.

Effective Date

The proposal would apply to decedents dying after the date of enactment.
10. Executor of estate and beneficiaries treated as related persons for disallowance of losses
Present Law

Section 267 disallows a deduction for any loss on the sale of an asset to a person related to the
taxpayer. For the purposes of section 267, the following parties are related persons: (1) a trust and
the trust's grantor, (2) two trusts with the same grantor, (3) a trust and a beneficiary of the trust, (4) a
trust and a beneficiary of another trust, if both trusts have the same grantor, and (5) a trust and a
corporation the stock of which is more than 50 percent owned by the trust or the trust's grantor.

Section 1239 disallows capital gain treatment on the sale of depreciable property to a related
person. For purposes of section 1239, a trust and any beneficiary of the trust are treated as related
persons, unless the beneficiary's interest is a remote contingent interest.

Neither section 267 or section 1239 presently treat an estate and a beneficiary of the estate as
related persons.

'° Application of the separate share rule is not elective; it is mandatory if there are
separate shares in the trust.

-57-



C. Optional Methods for Computing SECA Tax Combined

Present Law

The Self-Employment Contributions Act (“SECA”) imposes taxes on net earnings from
self-employment to provide social security coverage to self-employed workers. The maximum
amount of earnings subject to the SECA tax is coordinated with, and is set at the same level as,
the maximum level of wages and salaries subject to FICA taxes ($65,000 for OASDI taxes in
1997 and indexed annually, and without limit for the Hospital Insurance tax). Special rules
allow certain self-employed individuals to continue to maintain social security coverage during a
period of low income. The method applicable to farmers is slightly more favorable than the
method applicable to other self-employed persons.

A farmer may increase his or her self-employment income, for purposes of obtaining
social security coverage, by reporting two-thirds of the first $2,400 of gross income as net
earnings from self-employment, i.e., the optional amount of net earnings from self-employment
would not exceed $1,600. There is no limit on the number of times a farmer may use this
method. The optional method for non farm income is similar, also permitting two-thirds of the
first $2,400 of gross income to be treated as self-employment income. However, the optional
non farm method may not be used more than five times by any individual, and may only be used
if the taxpayer had net earnings from self-employment of $400 or more in at least two of the
three years immediately preceding the year in which the optional method is elected.

In general, to receive benefits, including Disability Insurance Benefits, under the Social
Security Act, a worker must have a minimum number of quarters of coverage. A minimum
amount of wages or self-employment income must be reported to obtain a quarter of coverage.
A maximum of four quarters of coverage may be obtained each year. In 1978, the amount of
earnings required to obtain a quarter of coverage began increasing each year. Starting in 1994, a
farmer could obtain only two quarters of coverage under the optional method applicable to
farmers.

Description of Proposal

The two current optional methods would be combined into a single combined optional
method. A self-employed worker could elect the proposed combined optional method an
unlimited number of times. If it is used, it must be applied to all self-employment earnings for
the year, both farm and non farm.

The $2,400 amount would be increased to an amount which would provide four quarters

of coverage in 1998, and would increase each year based on the earnings requirements under the
Social Security Act.

5.



Effective Date

Effective as if included in the amendments made by section 402 of the Tax Equity and
Fiscal Responsibility Act of 1982.

7. Availability of innocent spouse relief in context of partnership proceedings
Present Law

In general, an innocent spouse may be relieved of liability for tax, penalties and interest if
certain conditions are met (sec. 6013(e)). However, existing law does not provide the spouse of
a partner in a TEFRA partnership with a judicial forum to raise the innocent spouse defense with
respect to any tax or interest that relates to an investment ina TEFRA partnership.

Description of Proposal

The proposal would provide both a prepayment forum and a refund forum for raising the
innocent spouse defense in TEFRA cases.

With respect to a prepayment forum, the proposal would provide that within 60 days of
the date that a notice of computational adjustment relating to partnership items is mailed to the
spouse of a partner, the spouse could request that the assessment be abated. Upon receipt of
such a request, the assessment is abated and any reassessment will be subject to the deficiency
procedures. If an abatement is requested, the statute of limitations does not expire before the
date which is 60 days after the date of the abatement. If the spouse files a petition with the Tax
Court, the Tax Court only has jurisdiction to determine whether the requirements of section
6013(e) have been satisfied. In making this determination, the treatment of the partnership items
that gave rise to the liability in question is conclusive.

Alternatively, the proposal would provide that the spouse of a partner could file a claim
for refund to raise the innocent spouse defense. The claim has to be filed within 6 months from
the date that the notice of computational adjustment is mailed to the spouse. If the claim is not
allowed, the spouse could file a refund action. For purposes of any claim or suit under this
proposal, the treatment of the partnership items that gave rise to the liability in question is
conclusive.

Effective Date

Effective as if included in the amendments made by section 402 of the Tax Equity and
Fiscal Responsibility Act of 1982.

-28-



Vill. EXCISE TAX AND OTHER SIMPLIFICATION PROVISIONS

A. Increase De Minimis Limit for After-Market Alterations Subject to Heavy Truck
and Luxury Automobile Excise Taxes

Present Law —

An excise tax is imposed on retail sales of truck chassis and truck bodies suitable for use in a
vehicle with a gross vehicle weight of over 33,000 pounds. The tax is equal to 12 percent of the
retail sales price. An excise tax also is imposed on retail sales of luxury automobiles. The tax
currently is equal to 8 percent of the amount by which the retail sales price exceeds an inflation-
adjusted $30,000 base. (The rate is reduced by 1 percentage point per year through 2002, and the tax
is not imposed after 2002.) Anti-abuse rules prevent the avoidance of these taxes through separate
purchases of major component parts. With certain exceptions, tax at the rate applicable to the vehicle
is imposed on the subsequent installation of parts and accessories within six months after purchase of
a taxable vehicle. The exceptions include a de minimis exception for parts and accessories with an
aggregate price that does not exceed $200 (or such other amount as Treasury may be regulation
prescribe).

Description of Proposal

The tax on subsequent installation of parts and accessories would not apply to parts and
accessories with an aggregate price that does not exceed $1,000. Parts and accessories installed on a
vehicle on or before that date wold be taken into account in determining whether the $1,000 threshold
is exceeded. If the aggregate price of the pre-effective date parts and accessories does not exceed
$200, they would not be subject to tax unless the aggregate price of all additions exceeds $1,000.

Effective Date

The increase in the threshold for taxing after-market additions under the heavy truck and
luxury car excise taxes would be effective on January 1, 1998.

-64-



development and testing, for the brewer's personal or family use, or as supplies for certain vessels
and aircraft. .

Drawback on exported beer.--A domestic producer that exports beer may recover the tax
(receive a drawback") found to have been paid on the exported beer upon the "submission of such
evidence, records and certificates indicating exportation" required by regulations.

Imported beer transferred in bulk ‘ewery and imported wine transferred in bulk to
wineries.--Imported beer and wine are subject to tax when removed from customs custody.

Description of Proposals
Imported distilled spirits returned to plant.--Refunds or credits of the tax would be available

for imported bottled spirits that are returned to distilled spirits plants.

Cancellation of export bonds.--The certification requirement would be relaxed to allow the
bonds to be canceled if there is such proof of exportation as the Secretary may require.

Location of records of distilled spirits plant. --Records and reports would be permitted to be

maintained elsewhere other than on the plant premises

Transfers from brewery to distilled spirits plant.--Beer could be brought from any brewery for

use in the production of spirits. Such beer would be exempt from excise tax, subject to Treasury
regulations.

Sign not required for wholesaled dealers.--The requirement that a sign be posted would be
repealed.

Refund on retums of merchantable wine.--A refund or credit would be available in the case of

all domestic wine returned to bond, whether or not unmerchantable.

Increased sugar limits for certain wine.--Up to 60 percent sugar would be permitted in any
wine made from juice, such as cranberry or plum juice, with an acid content of 20 or more parts per

thousand.

Beer withdrawn for embassy use. Subject to Treasury's regulatory authority, an exemption
similar to that currently available for imported beer would be provided for domestic beer.

Beer withdrawn for destruction. An exemption from tax would be added for removals for
destruction, subject to Treasury regulations,

Drawback on exported beer. The certification requirement would be relaxed to allow a
drawback of tax paid if there is such proof of exportation as the Secretary may be regulations require.

-66-



Imported beer transferred in bulk to brewery and imported wine transferred in bulk to
wineries. Subject to Treasury regulations, beer imported in bulk could be withdrawn from customs

custody and transferred in bulk to a brewery without payment of tax. The proprietor of the brewery
to which the beer is transferred would be liable for the tax imposed on the withdrawal from customs
custody and the importer would be relieved of liability.

Effective Date

The proposal to repeal the requirement that wholesale liquor dealers post a sign outside their
place of business would take effect on the date of enactment. The other proposals would take effect
on the first day of the calendar quarter that begins at least 90 days after the date of enactment.

-67-



b. Suspend statute of limitations during bankruptcy proceedings
Present Law

The period for assessing tax with respect to partnership items generally is the longer of
the periods provided by section 6229 or section 6501. For partnership items that convert to
nonpartnership items, section 6229(f) provides that the period for assessing tax shall not expire
before the date which is 1 year after the date that the items become nonpartnership items.
Section 6503(h) provides for the suspension of the limitations period during the pendency of a
bankruptcy proceeding. However, this proposal only applies to the limitations periods provided
in sections 6501 and 6502.

Under present law, because the suspension proposal in section 6503(h) applies only to the
limitations periods provided in section 6501 and 6502, some uncertainty exists as to whether
section 6503(h) applies to suspend the limitations period pertaining to converted items provided
in section 6229(f) when a petition naming a partner as a debtor in a bankruptcy proceeding is
filed. As a result, the limitations period provided in section 6229(f) may continue to run during
the pendency of the bankruptcy proceeding, notwithstanding that the IRS is prohibited from
making an assessment against the debtor because of the automatic stay proposal of the
Bankruptcy Code.

Description of Proposal

The proposal would clarify that the statute of limitations is suspended for a partner who
is named in a bankruptcy petition. The suspension period is for the entire period during which
the IRS is prohibited by reason of the bankruptcy proceeding from making an assessment, and
for 60 days thereafter. The proposal does not purport to create any inference as to the proper
interpretation of present law.

Effective Date

All cases inl which the period of limitations has not expired under present law as of the
date of enactment.

c. Extend statute of limitations for bankrupt TMPs

Present Law

Section 6229(b)(1)(B) provides that the statute of limitations is extended with respect to
all partners in the partnership by an agreement entered into between the Tax Matters Partner
(TMP) and the IRS. However, Temp. Treas. Reg. secs. 301.623 1(a)(7)-1T(1)(4) and
301.6231(c)-7T(a) provide that upon the filing of a petition naming a partner as a debtor in a
bankruptcy proceeding, that partner's partnership items convert to nonpartnership items, and if
the debtor was the tax matters partner, such status terminates. These rules are necessary because

-25-



the court invalidated an agreement between the Secretary of the Treasury and Puerto Rico that
provided for the withholding of Puerto Rico income taxes from the wages of Federal employees.

Description of Proposal

The proposal would make any Commonwealth eligible to enter into an agreement with the
Secretary of the Treasury that would provide for income tax withholding from the wages of Federal
employees.

Effective Date
The proposal would be effective January 1, 1998.

3. Certain notices disregarded under provision increasing interest rate on large corporate
underpayments

Present Law

The interest rate on a large corporate underpayment of tax is the Federal short-term rate plus
five percentage points. A large corporate underpayment is any underpayment by a subchapter C
corporation of any tax imposed for any taxable period, if the amount of such underpayment for such
period exceeds $100,000. The large corporate underpayment rate generally applies to periods
beginning 30 days after the earlier of the date on which the first letter of proposed deficiency, a
statutory notice of deficiency, or a nondeficiency letter or notice of assessment or proposed
assessment is sent. For this purpose, a letter or notice is disregarded if the taxpayer makes a payment
equal to the amount shown on the letter or notice within that 30 day period.

The large corporate underpayment rate generally applies if the underpayment of tax for a
taxable period exceeds $100,000, even if the initial letter or notice of deficiency, proposed
deficiency, assessment, or proposed assessment is for an amount less than $100,000. Thus, for
example, under present law, a nondeficiency notice relating to a relatively minor mathematical error
by the taxpayer may result in the application of the large corporate underpayment rate to a
subsequently identified income tax deficiency.

Description of Proposal

For purposes of determining the period to which the large corporate underpayment rate
applies, any letter or notice would be disregarded if the amount of the deficiency, proposed
deficiency, assessment, or proposed assessment set forth in the letter or notice is not greater than
$100,000 (determined by not taking into account any interest, penalties, or additions to tax).

-77-



I, PROVISIONS RELATING TO INDIVIDUALS

A. Modifications to Standard Deduction of Dependents;
AMT Treatment of Certain Minor Children

Present Law

Standard deduction of dependents.--The standard deduction of a taxpayer for whom a
dependency exemption is allowed on another taxpayer’s return shall not exceed the lesser of (1)
the standard deduction for an individual taxpayer (projected to be $4,250 for 1998) or (2) the
greater of $500 (indexed)? or the dependent's earned income (sec. 63(c)(5)).

Taxation of uneamed income of children under age 14.--The tax on a portion of the

unearned income (e.g., interest and dividends) of a child under age 14 is the additional tax that
the child's custodial parent would pay if the child's unearned income were included in that
parent's income. The portion of the child's unearned income which is taxed at the parent's top
marginal rate is the amount by which the child's unearned income is more than the sum of (1)
$500° (indexed) plus (2) the greater of (a) $500* (indexed) or (b) the child's itemized deductions
directly connected with the production of the unearned income (sec. 1(g)).

Alternative minimum tax ("AMT") exemption for children under age 14--Single

taxpayers are entitled to an exemption from the alternative minimum tax ("AMT") of $33,750.
However, in the case of a child under age 14, his exemption from the AMT, in substance, is the
unused alternative minimum tax exemption of the child's custodial parent, limited to sum of
earned income and $1,400 (sec. 59(j)).

Description of Proposal

Standard deduction of dependents.--The proposal would provide that the standard
deduction for a taxpayer with respect to whom a dependency exemption is allowed on another
taxpayer’s return would be the lesser of (1) the standard deduction for individual taxpayers or (2)
the greater of: (a) $5005 (indexed for inflation as under present law), or (b) the individual’s
earned income plus $250. The $250 amount would be indexed for inflation after 1998.

Alternative minimum tax exemption for children under age 14.--The proposal would

provide that the AMT exemption amount for a child under age 14 would be equal to the lesser of

? The indexed amount is projected to be $700 for 1998.
3 Projected to be $700 for 1998.
* Projected to be $700 for 1998.
5 Projected to be $700 for 1998.

-2-


INTRODUCTION

The House Committee on Ways and Means has scheduled a markup of revenue
reconciliation provisions, beginning on June 11, 1997. This document,! prepared by the staff of
the Joint Committee on Taxation, provides a description of the Chairman’s mark for the tax
simplification provisions in the following areas: (I) individuals, (ID) businesses, (IIT)
partnerships, (IV) real estate investment trusts, (V) repeal of the short-short test for regulated
investment companies, (VI) taxpayer protections, (VII) estate, gift, and trust simplification,
(VIII) excise tax and other simplification. :

Separate documents provide descriptions of revenue reconciliation and technical
corrections provisions of the Chairman’s mark.

' This document may be cited as follows: Joint Committee on Taxation, Description of

Chairman’s Mark Relating to Tax Simplification Provisions (JCX-21-97), June 9, 1997.
-l-


C. Treatment of Construction Allowances Provided to Lessees

Present Law

Depreciation allowances for property used in a trade or business generally are determined
under the modified Accelerated Cost Recovery System ("MACRS'") of section 168.
Depreciation allowances for improvements made on leased property are determined under
MACRS, even if the MACRS recovery period assigned to the property is longer than the term of
the lease (sec. 168(i)(8)).” This rule applies regardless whether the lessor or lessee places the
leasehold improvements in service.’ If a leasehold improvement constitutes an addition or
improvement to nonresidential real property already placed in service, the improvement is
depreciated using the straight-line method over a 39-year recovery period, beginning in the
month the addition or improvement was placed in service (secs. 168(b)(3), ()(1), (d)(2), and

@)).

The gross income of a lessor of real property does not include any amount attributable to
the value of buildings erected, or other improvements made by, a lessee that revert to the lessor
at the termination of a lease (sec. 109).

Issues have arisen as to the proper treatment of amounts provided to a lessee by a lessor
for property to be constructed and used by the lessee pursuant to the lease ("construction
allowances"). Incentive payments have been includible in income as accessions to wealth?
However, a coordinated issue paper issued by the Internal Revenue Service on October 8, 1996,
provides that amounts received by a lessee from a lessor and expended by the lessee on assets
owned by the lessor were not includible in the lessee's income.

7 The Tax Reform Act of 1986 modified the Accelerated Cost Recovery System
("ACRS") to institute MACRS. Prior to the adoption of ACRS by the Economic Recovery Act
of 1981, taxpayers were allowed to depreciate the various components of a building as separate
assets with separate useful lives. The use of component depreciation was repealed upon the
adoption of ACRS. The denial of component depreciation also applies under MACRS, as
provided by the Tax Reform Act of 1986.

* Former Code sections 168(f)(6) and 178 provided that in certain circumstances, a
lessee could recover the cost of leasehold improvements made over the remaining term of the
lease. These provisions were repealed by the Tax Reform Act of 1986.

° John B. White, Inc. v. Comm., 55 T.C. 729 (1971), aff'd per curiam 458 F, 2d 989
(3d Cir.), cert. denied, 409 U.S. 876 (1972).

-14-


B. Increase De Minimis Threshold for Estimated Tax to $1,000 for Individuals

Present Law

An individual taxpayer generally is subject to an addition to tax for any underpayment of
estimated tax (sec. 6654). An individual generally does not have an underpayment of estimated
tax if he or she makes timely estimated tax payments at least equal to: (1) 100 percent of the tax
shown on the return of the individual for the preceding year (the “100 percent of last year’s
liability safe harbor”) or (2) 90 percent of the tax shown on the return for the current year. The
100 percent of last year’s liability safe harbor is modified to be a 110 percent of last year’s
liability safe harbor for any individual with an AGI of more than $150,000 as shown on the
return for the preceding taxable year. Income tax withholding from wages is considered to be a
payment of estimated taxes. In general, payment of estimated taxes must be made quarterly.
The addition to tax is not imposed where the total tax liability for the year, reduced by any
withheld tax and estimated tax payments, is less than $500.

Description of Proposal

The proposal would increase the $500 individual estimated tax de minimis threshold to
$1,000.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997.

-4-


3. Due date for furnishing information to partners of electing large partnerships
Present Law

A partnership required to file an income tax return with the Internal Revenue Service
must also furnish an information return to each of its partners on or before the day on which the
income tax return for the year is required to be filed, including extensions. Under regulations, a
partnership must file its income tax return on or before the fifteenth day of the fourth month
following the end of the partnership's taxable year (on or before April 15, for calendar year
partnerships). This is the same deadline by which most individual partners must file their tax
returns.

Description of Proposal

The proposal would provide that an electing large partnership (i.e., one that elects under
the reporting provision) must furnish information returns to partners by the first March 15
following the close of the partnership's taxable year.

The proposal would also provide that, if the partnership is required to provide copies of
the information returns to the Internal Revenue Service on magnetic media, each schedule (such
as each Schedule K-1) with respect to each partner is treated as a separate information return
with respect to the corrective periods and penalties that are generally applicable to all
information returns.

Effective Date
Partnership taxable years beginning after December 31, 1997.
4. Partnership returns required on magnetic media
Present Law
Partnerships are permitted, but not required, to provide the tax return of the partnership

(Form 1065), as well as copies of the schedules sent to each partner (Form K-1), to the Internal
Revenue Service on magnetic media.

Description of Proposal

The proposal would provide generally that any partnership is required to provide the tax
return of the partnership (Form 1065), as well as copies of the schedule sent to each partner
(Form K-1), to the Internal Revenue Service on magnetic media. An exception would be
provided for partnerships with 100 or fewer partners.

-20-


DESCRIPTION OF CHAIRMAN’S MARK
RELATING TO
TAX SIMPLIFICATION PROVISIONS

Scheduled for Markup
Before the
HOUSE COMMITTEE ON WAYS AND MEANS

on June 11, 1997

Prepared by the Staff
of the

JOINT COMMITTEE ON TAXATION

June 9, 1997

JCX-21-97



V. REPEAL THE SHORT-SHORT TEST FOR
REGULATED INVESTMENT COMPANIES

Present Law

A regulated investment company ("RIC") generally is treated as a conduit for Federal
income tax purposes. The Code provides conduit treatment by permitting a RIC to deduct
dividends paid to its shareholders in computing its taxable income. In order to qualify for
conduit treatment, the RIC must be a domestic corporation that, at all times during the taxable
year, is registered under the Investment Company Act of 1940 as a management company or as a
unit investment trust, or has elected to be treated as a business development company under that
Act (sec. 851(a)). In addition, a corporation must elect such status and must satisfy certain tests
(sec. 851(b)). In particular, a corporation must derive less than 30 percent of its gross income
from the sale or disposition of certain investments (including stock, securities, options, futures,
and forward contracts) held less than three months (the "short-short test") (sec. 851(b)(3)).

Description of Proposal
The proposal would repeal the short-short test.

Effective Date

The proposal would be effective for taxable years beginning after the date of enactment.

-43-



D. Treatment of Certain Reimbursed Expenses of Rural Letter Carriers' Vehicles

Present Law

A taxpayer who uses his or her automobile for business purposes may deduct the
business portion of the actual operation and maintenance expenses of the vehicle, plus
depreciation (subject to the limitations of sec. 280F). Alternatively, the taxpayer may elect to
utilize a standard mileage rate in computing the deduction allowable for business use of an
automobile that has not been fully depreciated. Under this election, the taxpayer's deduction
equals the applicable rate multiplied by the number of miles driven for business purposes and is
taken in lieu of deductions for depreciation and actual operation and maintenance expenses.

An employee of the U.S. Postal Service may compute his deduction for business use of
an automobile in performing services involving the collection and delivery of mail on a rural
route by using, for all business use mileage, 150 percent of the standard mileage rate.

Rural letter carriers are paid an equipment maintenance allowance (EMA) to compensate
them for the use of their personal automobiles in delivering the mail. The tax consequences of
the EMA are determined by comparing it with the automobile expense deductions that each
carrier is allowed to claim (using either the actual expenses method or the 150 percent of the
standard mileage rate). If the EMA exceeds the allowable automobile expense deductions, the
excess generally is subject to tax. If the EMA falls short of the allowable automobile expense
deductions, a deduction is allowed only to the extent that the sum of this shortfall and all other
miscellaneous itemized deductions exceeds two percent of the taxpayer's adjusted gross income.

Description of Proposal

The proposal would repeal the special rate for Postal Service employees of 150 percent of
the standard mileage rate. In its place, the proposal would require that the rate of reimbursement
provided by the Postal Service to rural letter carriers be considered to be equivalent to their
expenses. The rate of reimbursement that would be considered to be equivalent to their expenses
would be the rate of reimbursement contained in the 1991 collective bargaining agreement,
which may in the future be increased by no more than the rate of inflation.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997.

-7-



The optional method could be elected on a year-by-year basis. An election for a taxable
year would have to be filed with the original Federal income tax return for the year, and could
not be made retroactively by filing an amended return.

Effective Date

The proposal would be effective for taxable years beginning after January 1, 1998.

6-


the estate for its first taxable year, taking into account any extensions. A conforming change would
be made to section 2652(b) for generation-skipping transfer tax purposes.

For this purpose, a qualified revocable trust would be any trust (or portion thereof) which was
treated under section 676 as owned by the decedent with respect to whom the election is being made.

Effective Date
The proposal would apply to decedents dying after the date of enactment.
8. Distributions during first 65 days of taxable year of estate
Present Law
In general, trusts and estates are treated as conduits for Federal income tax purposes; income
received by a trust or estate that is distributed to a beneficiary in the trust or estate's taxable year
"ending with or within" the taxable year of the beneficiary is taxable to the beneficiary in that year;
income that is retained by the trust or estate is initially taxable to the trust or estate. In the case of
distributions of previously accumulated income by trusts (but not estates), there may be additional tax
under the so-called "throwback" rules if the beneficiary to whom the distributions were made has
marginal rates higher than those of the trust. Under the "65-day rule," a trust may elect to treat

distributions paid within 65 days after the close of its taxable year as paid on the last day of its
taxable year. The 65-day rule is not applicable to estates.

Description of Proposal
The proposal would extend application of the 65-day rule to distributions by estates. Thus, an
executor could elect to treat distributions paid within 65 days after the close of the estate's taxable
year as having been paid on the last day of such taxable year.
Effective Date
The proposal would apply to taxable years beginning after the date of enactment.
9. Separate share rules available to estates

Present Law

Trusts with more than one beneficiary must use the "separate share" rule in order to provide
different tax treatment of distributions to different beneficiaries to reflect the income earned by

~56-



for its stock (and assumption of liabilities) immediately before the time that the REIT ceased to
own 100 percent of the subsidiary's stock, or ceased to be a REIT as the case may be

Distribution requirements

To satisfy the distribution requirement, a REIT must distribute as dividends to its
shareholders during the taxable year an amount equal to or exceeding (i) the sum of 95 percent
of its REITTI other than net capital gain income and 95 percent of the excess of its net income
from foreclosure property over the tax imposed on that income minus (ii) certain excess noncash
income (described below).

Excess noncash items include (a) the excess of the amounts that the REIT is required to
include in income under section 467 with respect to certain rental agreements involving deferred
rents, over the amounts that the REIT otherwise would recognize under its regular method of
accounting, (2) in the case of a REIT using the cash method of accounting, the excess of the
amount of original issue discount and coupon interest that the REIT is required to take into
account with respect to a loan to which section 1274 applies, over the amount of money and fair
market value of other property received with respect to the loan, and (3) income arising from the
disposition of a real estate asset in certain transactions that failed to qualify as like-kind
exchanges under section 1031.

Description of Proposal

Overview

The proposal would modify many of the provisions relating to the requirements for
qualification as, and the taxation of, a REIT.

Clarification of limitation on maximum number of shareholders

The proposal would replace the rule that disqualifies a REIT for any year in which the
REIT failed to comply with regulations to ascertain its ownership, with an intermediate penalty
for failing to do so. The penalty would be $25,000 ($50,000 for intentional violations) for any
year in which the REIT did not comply with the ownership regulations. The REIT also would be
required, when requested by the IRS, to send curative demand letters.

In addition, a REIT that complied with the regulations for ascertaining its ownership, and

which did not know, or have reason to know, that it was so closely held as to be classified as a
personal holding company, would not be treated as a personal holding company.

De minimis rule for tenant service income

The proposal would permit a REIT to render a de minimis amount of impermissible
services to tenants, or in connection with the management of property, and still treat amounts

-39-



5. Exclusion of partial settlements from 1-year limitation on assessment
Present Law

The period for assessing tax with respect to partnership items generally is the longer of
the periods provided by section 6229 or section 6501. For partnership items that convert to
nonpartnership items, section 6229(f) provides that the period for assessing tax shall not expire
before the date which is 1 year after the date that the items become nonpartnership items.
Section 6231(b)(1)(C) provides that the partnership items of a partner for a partnership taxable
year become nonpartnership items as of the date the partner enters into a settlement agreement
with the IRS with respect to such items.

Description of Proposal

The proposal would provide that if a partner and the IRS enter into a settlement
agreement with respect to some but not all of the partnership items in dispute for a partnership
taxable year and other partnership items remain in dispute, the period for assessing any tax
attributable to the settled items is determined as if such agreement had not been entered into.
Consequently, the limitations period that is applicable to the last item to be resolved for the
partnership taxable year is controlling with respect to all disputed partnership items for the
partnership taxable year. The proposal does not purport to create any inference as to the proper
interpretation of present law.

Effective Date
Settlements entered into after the date of enactment.
6. Extension of time for filing a request for administrative adjustment

Present Law

If an agreement extending the statute is entered into with respect to a non-TEFRA statute
of limitations, that agreement also extends the statute of limitations for filing refund claims (sec.
6511(c)). There is no comparable proposal for extending the time for filing refund claims with
respect to partnership items subject to the TEFRA partnership rules.

Description of Proposal

The proposal would provide that if a TEFRA statute extension agreement is entered into,
that agreement also extends the statute of limitations for filing refund claims attributable to
partnership items or affected items until 6 months after the expiration of the limitations period
for assessments.

-27-



VI. TAXPAYER PROTECTIONS
A. Provide Reasonable Cause Exception for Additional Penalties
Present Law
Many penalties in the Code may be waived if the taxpayer establishes reasonable cause.
For example, the accuracy-related penalty (sec. 6662) may be waived with respect to any item if

the taxpayer establishes reasonable cause for his treatment of the item and that he acted in good
faith (sec. 6664(c)).

Description of Proposal

The proposal would provide that the following penalties may be waived if the failure is
shown to be due to reasonable cause and not willful neglect:

(1) the penalty for failure to make a report in connection with deductible employee
contributions to a retirement savings plan (sec. 6652(g));

(2) the penalty for failure to make a report as to certain small business stock (sec.
6652(k));

(3) the penalty for failure ofa foreign corporation to file a return of personal holding
company tax (sec. 6683); and

(4) the penalty for failure to make required payments for entities electing not to have the
required taxable year (sec. 7519).

Effective Date

The proposal would be effective for taxable years beginning after the date of enactment.

-44-



of the automatic stay proposal contained in 11 U.S.C. sec. 362(a)(8). As a result, if a consent to
extend the statute of limitations is signed by a person who would be the TMP but for the fact that
at the time that the agreement is executed the person was a debtor in a bankruptcy proceeding,
the consent would not be binding on the other partners because the person signing the agreement
was no longer the TMP at the time that the agreement was executed.

Description of Proposal

The proposal would provide that unless the IRS is notified of a bankruptcy proceeding in
accordance with regulations, the IRS can rely on a statute extension signed by a person who is
the Tax Matters Partner but for the fact that said person was in bankruptcy at the time that the
person signed the agreement. Statute extensions granted by a bankrupt TMP in these cases are
binding on all of the partners in the partnership. The proposal is not intended to create any
inference as to the proper interpretation of present law.

Effective Date

Effective for extension agreements entered into after the date of enactment.
4. Expansion of small partnership exception
Present Law

TEFRA established unified audit rules applicable to all partnerships, except for
partnerships with 10 or fewer partners, each of whom is a natural person (other than a
nonresident alien) or an estate, and for which each partner's share of each partnership item is the
same as that partner's share of every other partnership item. Partners in the exempted
partnerships are subject to regular deficiency procedures.

Description of Proposal

The proposal would permit a small partnership to have a C corporation as a partner or to
specially allocate items without jeopardizing its exception from the TEFRA rules. However, the
proposal retains the prohibition of present law against having a flow-through entity (other than
an estate of a deceased partner) as a partner for purposes of qualifying for the small partnership
exception.

Effective Date

Partnership taxable years ending after the date of enactment.

-26-


17. Authority to waive requirement of U.S. trustee for qualified domestic trusts
Present Law

In order for a trust to be a QDT, a U.S. trustee must have the power to approve all corpus
distributions from the trust. In some countries, trusts cannot have any U.S. trustees. As a result, trusts
established in those countries cannot qualify as a QDT.

Description of Proposal

In order to permit the establishment of a QDT in countries that prohibit a trust from having a U.S.
trustee, the proposal would provide the Treasury Department with regulatory authority to waive the
Tequirement that a QDT have a U.S. trustee. It is anticipated that such regulations, if any, would provide
an alternative mechanism under which the U.S. would retain jurisdiction to impose gift and estate tax
on transfers by the surviving spouse of the property transferred by the deceased spouse.

Effective Date

The proposal would apply to decedents dying after the date of enactment.

-63-



(1) $33,750 or (2) the sum of the child’s earned income plus $5,000. The $5,000 amount would
be indexed for inflation after 1998.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1997.


appropriate.'” Separate treatment may be appropriate, for example, should changes in the law
necessitate such treatment for any items.

Under the proposal, the taxable income of an electing large partnership.would be
computed in the same manner as that of an individual, except that the items described above
would be separately stated and certain modifications would be made. These modifications would
include disallowing the deduction for personal exemptions, the net operating loss deduction, and
certain itemized deductions." All limitations and other provisions affecting the computation of
taxable income or any credit (except for the at risk, passive loss and itemized deduction
limitations, and any other proposal specified in regulations) would be applied at the partnership
(and not the partner) level.

All elections affecting the computation of taxable income or any credit generally would
be made by the partnership.

An “electing large partnership" would be any partnership that elects under the proposal, if
the number of partners in the preceding partnership taxable year is 100 or more. The number of
partners would be determined by counting only persons directly holding partnership interests in
the taxable year, including persons holding through nominees; persons holding indirectly (e.g.,
through another partnership) would not be counted. To the extent so provided in regulations, if
the number of partners in any taxable year falls below 100, the partnership would not be treated
as an electing large partnership. The election apply to the year for which made and all
subsequent years and could not be revoked without the Secretary's consent.

Service partnerships.--An electing large partnership would not include any partnership if
substantially all the partners are: (1) individuals performing substantial services in connection
with the partnership's activities, or personal service corporations the owner-employees of which
perform such services, (2) retired partners who had performed such services; or (3) spouses of
partners who had performed such services. In addition, the term "partner" would not include any
individual performing substantial services in connection with the partnership's activities and
holding a partnership interest, or an individual who formerly performed such services and who
held a partnership interest at the time the individual performed such services.

° In determining the amounts required to be separately taken into account by a partner, those
provisions of the large partnership rules governing computations of taxable income would be
applied separately with respect to that partner by taking into account that partner's distributive
share of the partnership's items of income, gain, loss, deduction or credit. This rule would permit
partnerships to make otherwise valid special allocations of partnership items to partners.

"' An electing large partnership would be allowed a deduction under section 212 for expenses
incurred for the production of income, subject to 70-percent disallowance. No income from an
electing large partnership would be treated as fishing or farming income.

-17-



5. Amend "5 or 5 power"
Present Law

The exercise or release of a general power of appointment generally is considered a gift by
the person holding the power (sec. 2514(b)). A special rule, however, provides that the lapse of a
power of appointment during the life of the person holding the power is considered a release {and
thus a taxable gift) only to the extent that the value of the property over which the power lapsed
exceeds the greater of $5,000 or 5 percent of the value of the assets of the trust (sec. 2514(e)). A
similar provision applies for purposes of estate taxation (sec. 2041(b)(2)).

Description of Proposal

The limitations in sections 2514(e) and 2041(b)(2) would be increased to the greater of
$10,000 or 5 percent.

Effective Date

This proposal would apply to lapses occurring in taxable years beginning after the date of
enactment.

6. Treatment for estate tax purposes of short-term obligations held by nonresident aliens

Present Law

The United States imposes estate tax on assets of noncitizen nondomiciliaries that were
situated in the United States at the time of the individual's death. Debt obligations of a U.S. person,
the United States, a political subdivision of a State, or the District of Columbia are considered
property located within the United States if held by a nonresident not a citizen of the United States
(sec. 2014(c)).

Special rules apply to treat certain bank deposits and debt instruments the income from which
qualifies for the bank deposit interest exemption and the portfolio interest exemption as property
from without the United States despite the fact that such items are obligations of a U.S. person, the
United States, a political subdivision of a State, or the District of Columbia (sec. 2105(b)). Income
from such items is exempt from U.S. income tax in the hands of the nonresident recipient (secs.
871(h) and 871(i)(2)(A)). The effect of these special rules is to exclude these items from the U.S.
gross estate of a nonresident not a citizen of the United States. However, because of an amendment to
section 871(h) made by the Tax Reform Act of 1986, these special rules no longer cover obligations
that generate short-term OID income despite the fact that such income is exempt from U.S. income
tax in the hands of the nonresident recipient (sec. 871(g)(1)(B)(i)).

-54-



Effective Date

The proposal would be effective for purposes of determining interest for periods after
December 31, 1997.

-78-



As a result of these changes made by REA and the Tax Reform Act of 1986, the transfer tax
treatment of married couples residing in a community property state is unclear where either spouse is
covered by a qualified plan.

Description of Proposal

The proposal would clarify that the marital deduction is available with respect to a nonparticipant
spouse's interest in an IRA, SEP, or qualified pension plan (collectively hereinafter referred to as a
"plan") attributable to community property laws where he or she predeceases the participant spouse.
Under the proposal, the nonparticipant spouse's interest in a plan that passes to the surviving participant
spouse is deemed to qualify for treatment as qualified terminable interest property (QTIP) under section
2056(b)(7).2

Effective Date

The proposal would apply to decedents dying, or waivers, transfers and disclaimers made, after
the date of enactment.

15. Treatment under qualified domestic trust rules of forms of ownership which are not trusts

Present Law

A marital deduction generally is allowed for estate and gift tax purposes for the value of property
passing to a spouse. The marital deduction is not available for property passing to an alien spouse
outside a qualified domestic trust (“QDT”). An estate tax generally is imposed on corpus distributions
from a QDT.

Trusts are not permitted in some countries (e.g., many civil law countries).”! As a result, it is not
possible to create a QDT in those countries.

* In general, QTIP is property which passes from the decedent, in which the surviving
spouse has a qualifying income interest for life, and which the executor elected to treat as QTIP.
A surviving spouse generally has a qualifying income interest for life if he or she is entitled to all
the income from the property payable at least annually, and no person has the power to appoint
any part of the property to any person other than the surviving spouse.

?) Note that in some civil law States (e.g., Louisiana) an entity similar to a trust, called a
usufruct, exists.

-61-



IV. MODIFICATIONS OF RULES FOR REAL ESTATE INVESTMENT TRUSTS

Present Law

Overview

In general, a real estate investment trust ("REIT") is an entity that receives most of its
income from passive real estate related investments and that receives conduit treatment for
income that is distributed to shareholders. If an entity meets the qualifications for REIT status,
the portion of its income that is distributed to the investors each year generally is taxed to the
investors without being subjected to a tax at the REIT level; the REIT generally is subject to a
corporate tax only on the income that it retains and on certain income from property that
qualifies as foreclosure property.

Election to be Treated as a REIT

In order to qualify as a REIT, and thereby receive conduit treatment, an entity must elect
REIT status. A newly-electing entity generally cannot have earnings and profits accumulated
from any year in which the entity was in existence and not treated as a REIT (sec. 857(a)(3)). To
satisfy this requirement, the entity must distribute, during its first REIT taxable year, any
earnings and profits that were accumulated in non-REIT years. For this purpose, distributions by
the entity generally are treated as being made from the most recently accumulated earnings and
profits.

Taxation of REITs

Overview

In general, if an entity qualifies as a REIT by satisfying the various requirements
described below, the entity is taxable as a corporation on its "real estate investment trust taxable
income" ("REITTI"), and also is taxable on certain other amounts (sec. 857). REITTI is the
taxable income of the REIT with certain adjustments (sec. 857(b)(2)). The most significant
adjustment is a deduction for dividends paid. The allowance of this deduction is the mechanism
by which the REIT becomes a conduit for income tax purposes.

Capital gains

A REIT that has a net capital gain for a taxable year generally is subject to tax on such
capital gain under the capital gains tax regime generally applicable to corporations (sec.
857(b)(3)). However, a REIT may diminish or eliminate its tax liability attributable to such
capital gain by paying a "capital gain dividend" to its shareholders (sec. 857(b)(3)(C)). A capital
gain dividend is any dividend or part of a dividend that is designated by the payor REIT as a
capital gain dividend in a written notice mailed to shareholders. Shareholders who receive

-34-


Effective Date

The proposal would be effective on the date of enactment.
3. Application of net worth requirement for awards of litigation costs

Present Law

Any person who substantially prevails in any action brought by or against the United States in
connection with the determination, collection, or refund of any tax, interest, or penalty may be
awarded reasonable administrative costs incurred before the IRS and reasonable litigation costs
incurred in connection with any court proceeding. A person who substantially prevails must meet
certain net worth requirements to be eligible for an award of administrative or litigation costs. In
general, only an individual whose net worth does not exceed $2,000,000 is eligible for an award, and
only a corporation or partnership whose net worth does not exceed $7,000,000 is eligible for an
award. (The net worth determination with respect to a partnership or S corporation applies to all
actions that are in substance partnership actions or $ corporation actions, including unified
entity-level proceedings under sections 6226 or 6228, that are nominally brought in the name of a
partner or a shareholder.)

Although the net worth requirements are explicit for individuals, corporations, and
partnerships, it is not clear which net worth requirement is to apply to other potential litigants. It is
also unclear how the individual net worth rules are to apply to individuals filing a joint tax return.

Description of Proposal

The proposal would provide that the net worth limitations currently applicable to individuals
also apply to estates and trusts. The proposal also would provide that individuals who file a joint tax
return shall be treated as one individual for purposes of computing the net worth limitations.
Consequently, the net worths of both spouses would be aggregated for purposes of this computation.
An exception to this rule would be provided in the case of a spouse otherwise qualifying for innocent
spouse relief. ‘

Effective Date

The proposal would apply to proceedings commenced after the date of enactment.

-74-



capital gain dividends treat the amount of such dividends as long-term capital gain regardless of
their holding period of the stock (sec. 857(b)(3)(C)).

A regulated investment company ("RIC"), but not a REIT, may elect to retain and pay
income tax on net long-term capital gains it received during the tax year. If a RIC makes this
election, the RIC shareholders must include in their income as long-term capital gains their
proportionate share of these undistributed long-term capital gains as designated by the RIC. The
shareholder is deemed to have paid the shareholder's share of the tax, which can be credited or
refunded to the shareholder. Also, the basis of the shareholder's shares is increased by the
amount of the undistributed long-term capital gains (less the amount of capital gains tax paid by
the RIC) included in the shareholder's long-term capital gains.

Income from foreclosure property

In addition to tax on its REITTI, a REIT is subject to tax at the highest rate of tax paid by
corporations on its net income from foreclosure property (sec. 857(b)(4)). Net income from
foreclosure property is the excess of the sum of gains from foreclosure property that is held for
sale to customers in the ordinary course of a trade or business and gross income from foreclosure
property (other than income that otherwise would qualify under the 75-percent income test
described below) over all allowable deductions directly connected with the production of such
income.

Foreclosure property is any real property or personal property incident to such real
property that is acquired by a REIT as a result of default or imminent default on a lease of such
property or indebtedness secured by such property, provided that (unless acquired as foreclosure
property), such property was not held by the REIT for sale to customers (sec. 856(e)). A property
generally may be treated as foreclosure property for a period of two years after the date the
property is acquired by the REIT. The IRS may grant extensions of the period for treating the
property as foreclosure property if the REIT establishes that an extension of the grace period is
necessary for the orderly liquidation of the REIT's interest in the property. The grace period
cannot be extended beyond six years from the date the property is acquired by the REIT.

Property will cease to be treated as foreclosure property if, after 90 days after the date of
acquisition, the REIT operates the foreclosure property in a trade or business other than through
an independent contractor from whom the REIT does not derive or receive any income (sec.

856(e)(4)(C)).

Income or loss from prohibited transactions

In general, a REIT must derive its income from passive sources and not engage in any
active trade or business. Accordingly, in addition to the tax on its REITTI and on its net income
from foreclosure property, a 100 percent tax is imposed on the net income of a REIT from
“prohibited transactions" (sec. 857(b)(6)). A prohibited transaction is the sale or other
disposition of property described in section 1221(1) of the Code (property held for sale in the

-35-



conviction, an officer or employee of the United States would be dismissed from office or
discharged from employment.

Civil damages

The proposal would amend the provision providing for civil damages for unauthorized
disclosure by also providing for civil damages for unauthorized inspection. Damages would be
available for unauthorized inspection that occurs either knowingly or by reason of negligence.
Accidental or inadvertent inspection that may occur (such as, for example, by making an error in
typing in a TIN) would not be subject to damages because it would not meet this standard. The
proposal also would provide that no damages are available to a taxpayer if that taxpayer
requested the inspection or disclosure.

The proposal also would require that, if any person is criminally charged by indictment
or information with inspection or disclosure of a taxpayer’s return or return information in
violation of section 7213(a) or (b), section 7213A (as added by the bill), or 18 USC section
1030(a)(2)(B), the Secretary notify that taxpayer as soon as practicable of the inspection or
disclosure.

Effective Date

The proposal would be effective for violations occurring on or after the date of enactment.

-50-


only issue such a notice if a deficiency would have arisen in the absence of the net loss from
TEFRA partnerships.

The Tax Court would be granted jurisdiction to determine the correctness of such an
adjustment as well as to make a declaration with respect to any other item for the taxable year to
which the notice of adjustment relates, except for partnership items and affected items which
require partner-level determinations. No tax is due upon such a determination, but a decision of
the Tax Court is treated as a final decision, permitting an appeal of the decision by either the
taxpayer or the IRS. An adjustment determined to be correct would thus have the effect of
increasing the taxable income that is deemed to have been reported on the taxpayer's return. If
the taxpayer's partnership items were then adjusted in a subsequent proceeding, the IRS has
preserved its ability to collect tax on any increased deficiency attributable to the nonpartnership
items. .

Alternatively, if the taxpayer chooses not to contest the notice of adjustment within the
90-day period, the proposal would provide that when the taxpayer's partnership items are finally
determined, the taxpayer has the right to file a refund claim for tax attributable to the items
adjusted by the earlier notice of adjustment for the taxable year. Although a refund claim is not
generally permitted with respect to a deficiency arising from a TEFRA proceeding, such a rule is
appropriate with respect to a defaulted notice of adjustment because taxpayers may not challenge
such a notice when issued since it does not require the payment of additional tax.

In addition, the proposal would incorporate a number of provisions intended to clarify the
coordination between TEFRA audit proceedings and individual deficiency proceedings. Under
these provisions, any adjustment with respect to a non-partnership item that caused an increase
in tax liability with respect to a partnership item would be treated as a computational adjustment
and assessed after the conclusion of the TEFRA proceeding. Accordingly, deficiency procedures
do not apply with respect to this increase in tax liability, and the statute of limitations applicable
to TEFRA proceedings are controlling.

Effective Date
Partnership taxable years ending after the date of enactment.
2. Partnership return to be determinative of audit procedures to be followed
Present Law
TEFRA established unified audit rules applicable to all partnerships, except for
partnerships with 10 or fewer partners, each of whom is a natural person (other than a
nonresident alien) or an estate, and for which each partner's share of each partnership item is the

same as that partner's share of every other partnership item. Partners in the exempted
partnerships are subject to regular deficiency procedures.

-23-



4. Clarifications relating to disclaimers
Present Law

Historically, there must be acceptance of a gift in order for the gift to be completed under
State law and there is no taxable gift for Federal gift tax purposes unless there is a completed gift.
Most States have rules that provide that, where there is a disclaimer of a gift, the property passes to
the person who would be entitled to the property had the disclaiming party died before the purported
transfer.

In the Tax Reform Act of 1976, Congress provided a uniform disclaimer rule (section 2518)
that specified how and when a disclaimer must be made in order to be effective for Federal transfer
tax purposes. Under section 2518, a disclaimer is effective for Federal transfer tax purposes if it is an
irrevocable and unqualified refusal to accept an interest in property and certain other requirements
are satisfied. One of these other requirements is that the disclaimer generally must be made in writing
not later than nine months after the transfer creating the interest occurs. In order to be a qualified
disclaimer, the disclaiming person must not have accepted the disclaimed interest or any of its
benefits. Section 2518 is not presently effective for Federal tax purposes other than transfer taxes
(e.g., income taxes).

In 1981, Congress added a rule to section 2518 that allowed certain transfers of property to be
treated as a qualified disclaimer. In order to qualify, these transfer-type disclaimers must be a written
transfer of the disclaimant's "entire interest in the property" to persons who would have received the
property had there been a valid disclaimer under State law (sec. 2518(c)(3)). Like other disclaimers,
the transfer-type disclaimer generally must be made within nine months of the transfer creating the
interest.

Description of Proposal

The proposal would allow a transfer-type disclaimer of an "undivided portion" of the
disclaimant transferor's interest in property to qualify under section 2518. Also, the proposal would
allow a spouse to make a qualified transfer-type disclaimer where the disclaimed property is
transferred to a trust in which the disclaimant spouse has an interest (e.g., a credit shelter trust).
Finally, the proposal would provide that a qualified disclaimer for transfer tax purposes under section
2518 also would be effective for Federal income tax purposes (e.g., disclaimers of interests in
annuities and income in respect of a decedent).

Effective Date

The proposal would apply to disclaimers made after the date of enactment.

-53-



Description of Proposal

The proposal would provide the Treasury Department with regulatory authority to treat as trusts
legal arrangements that have substantially the same effect as a trust.

Effective Date

The proposal would apply to decedents dying after the date of enactment.

16. Opportunity to correct certain failures under section 2032A.

Present Law

For estate tax purposes, an executor may elect to value certain real property used in farming or
other closely held business operations at its current use value rather than its highest and best use (sec.
2032A). A written agreement signed by each person with an interest in the property must be filed with
the election.

Treasury regulations require that a notice of election and certain information be filed with the
Federal estate tax return (Treas. Reg. sec. 20.2032A-8), The administrative policy of the Treasury
Department is to disallow current use valuation elections unless the required information is supplied.

Under procedures prescribed by the Treasury Department, an executor who makes the election
and substantially complies with the regulations but fails to provide all required information or the
signatures of all persons with an interest in the property may supply the missing information within a
reasonable period of time (not exceeding 90 days) after notification by the Treasury Department.

Description of Proposal

The proposal would extend the procedures allowing subsequent submission of information to any
executor who makes the election and submits the recapture agreement, without regard to compliance with
the regulations. Thus, the proposal would allow the current use valuation election if the executor
supplies the required information within a reasonable period of time (not exceeding 90 days) after
notification by the IRS. During that time period, the proposal also would allow the addition of signatures
to a previously filed agreement. No inference would be intended as to whether the Treasury Department
already has the authority to adopt this position under present law.

Effective Date

The proposal would apply to decedents dying after the date of enactment

~62-



D. Clarify Statute of Limitations for Items from Pass-Through Entities .. .

E. Awarding of Administrative Costs and Attorneys Fees .............

F. Prohibition on Browsing ..... 22.2... 0.0 cece cece eee eee

Vil. ESTATE, GIFT, AND TRUST SIMPLIFICATION ................

AwkwWN

16.
17.

Eliminate gift tax filing requirements for gifts to charities .
Clarification of waiver of certain rights of recovery .....
Transitional rule under section 2056A
Clarifications relating to disclaimers . . .
Amend “5 or 5 power” 200. e eee ee
Treatment for estate tax purposes of short-term obligations

held by nonresident aliens..................
Certain revocable trusts treated as part of estate........
Distributions during first 65 days of taxable year of estate an
Separate share rules available to estates ....................,
Executor of estate and beneficiaries treated as related persons

for disallowance of losses. ..... 2.0.00... ccc eee cence
Limitation on taxable year of estates... .
Simplified taxation of earnings of pre-need funeral trusts 2.2.22...
Adjustments for gifts within 3 years of decedent’s death.........
Clarify relationship between community property rights

and retirement benefits 26.60.0000
Treatment under qualified domestic trust rules of forms

of ownership which are not trusts.........0....0..0.00000-.
Opportunity to correct certain failures under section 2032A
Authority to waive requirement of U.S. trustee for qualified
domestic trusts 0.0 e eee cece eee

A. Increase De Minimis Limit for After-Market Alterations Subject
to Heavy Truck and Luxury Automobile Excise Taxes .............

B. Simplification of Excise Taxes on Distilled Spirits, Wine, and Beer .. . .

Gi)

47
48
49
51
51.
51
52
33
54
54
55
56
56
57
58
58
59
60

61
62

63

64

64

65


section 337). In addition, any pre-REIT earnings and profits of the subsidiary must be
distributed before the end of the REIT's taxable year.

Effective Date

The proposals would be effective for taxable years beginning after the date of enactment.

-42-



received with respect to that property as rent. The value of the impermissible services could not
exceed one percent of the gross income from the property. For these purposes, the services could
not be valued at less than 150 percent of the REIT's direct cost of the services.

Attribution rules applicable to tenant ownership

The proposal would modify the application of section 318(a)(3)(A) (attribution to
partnerships) for purposes of defining rent in section 856(d)(2), so that attribution would occur
only when a partner owns a 25 percent or greater interest in the partnership.

redit for aid by REIT on retained capital gain:

The proposal would permit a REIT to elect to retain and pay income tax on net long-term
capital gains it received during the tax year, just as a RIC is permitted under present law. Thus, if
a REIT made this election, the REIT shareholders would include in their income as long-term
capital gains their proportionate share of the undistributed long-term capital gains as designated
by the REIT. The shareholder would be deemed to have paid the shareholder's share of the tax,
which could be credited or refunded to the shareholder. Also, the basis of the shareholder's
shares would be increased by the amount of the undistributed long-term capital gains (less the
amount of capital gains tax paid by the REIT) included in the shareholder's long-term capital
gains,

Repeal of 30-percent gross income requirement

The proposal would repeal the rule that requires less than 30 percent of a REIT's gross
income be derived from gain from the sale or other disposition of stock or securities held for less
than one year, certain real property held less than four years, and property that is sold or
disposed of in a prohibited transaction.

Modification of earnings and profits for determining whether REIT has earnings and

profits from non-REIT year

The proposal would change the ordering rule for purposes of the requirement that
newly-electing REITs distribute earnings and profits that were accumulated in non-REIT years.
Under the proposal, distributions of accumulated earnings and profits generally would be treated
as made from the entity's earliest accumulated earnings and profits, rather than the most recently
accumulated earnings and profits. These distributions would not be treated as distributions for
purposes of calculating the dividends paid deduction.

Treatment of foreclosure property

The proposal would lengthen the original grace period for foreclosure property until the
last day of the third full taxable year following the election. The grace period also could be
extended for an additional three years by filing a request to the IRS. Under the proposal, a REIT

-40-



B. Simplification of Excise Taxes on Distilled Spirits, Wine, and Beer

Present Law

Imported distilled spirits returned to plant.-- Excise tax that has been paid on domestic

distilled spirits is credited or refunded if the spirits are later returned to bonded premises. Tax is
imposed on imported bottled spirits when they are withdrawn from customs custody, but the tax is
not refunded or credited if the spirits are later returned to bonded premises.

Cancellation of export bonds.--An exporter that withdraws distilled spirits from bonded
warehouses for export or transportation to a customs bonded warehouse without the payment of tax
must furnish a bond to cover the withdrawal. The required bonds are canceled "on the submission of
such evidence, records, and certification indicating exportation as the Secretary may by regulations
prescribe."

- Location of records of distilled spirits plant.-- Proprietors of distilled spirits plants are

required to maintain records and reports relating to their production, storage, denaturation, and
processing activities on the premises where the operations covered by the record are carried on.

Transfers from brewery to distilled spirits plant.--A distilled spirits plant may receive on its

bonded premises beer to be used in the production of distilled spirits only if the beer is produced on
contiguous brewery premises.

Sign not required for wholesale dealers.--Wholesale liquor dealers are required to post a sign

identifying the firm as such. Failure to do so is subject to a penalty.

Refund on returns of merchantable wine.--Excise tax paid on domestic wine that is returned to
bond as unmerchantable is refunded or credited, and the wine is once again treated as wine in bond
on the premises of a bonded wine cellar.

Increased sugar limits for certain wine.--Natural wines may be sweetened to correct high acid
content. For most wines, however, sugar cannot constitute more than 35 percent (by volume) of the
combined sugar and juice used to produce the wine. Up to 60 percent sugar may be used in wine
made from loganberries, currants, and gooseberries. If the amount of sugar used exceeds the
applicable limitation, the wine must be labeled "substandard."

Beer withdrawn for embassy use.--Imported beer to be used for the family and official use of
representatives of foreign governments or public international organizations may be withdrawn from
customs bonded warehouses without payment of excise tax. No similar exemption applies to
domestic beer withdrawn from a brewery or entered into a bonded customs warehouse for the same
authorized use.

Beer withdrawn for destruction.--Removals of beer from a brewery are exempt from tax if the
removal is for export, because the beer is unfit for beverage use, for laboratory analysis, research,

-65-



I. PROVISIONS RELATING TO BUSINESSES GENERALLY

A. Modifications to Look-Back Method for Long-Term Contracts

Present Law

Taxpayers engaged in the production of property under a long-term contract generally
must compute income from the contract under the percentage of completion method. Under the
percentage of completion method, a taxpayer must include in gross income for any taxable year
an amount that is based on the product of (1) the gross contract price and (2) the percentage of
the contract completed as of the end of the year. The percentage of the contract completed as of
the end of the year is determined by comparing costs incurred with respect to the contract as of
the end of the year with estimated total contract costs.

Because the percentage of completion method relies upon estimated, rather than actual,
contract price and costs to determine gross income for any taxable year, a “look-back method" is
applied in the year a contract is completed in order to compensate the taxpayer (or the Internal
Revenue Service) for the acceleration (or deferral) of taxes paid over the contract term. The first
step of the look-back method is to reapply the percentage of completion method using actual
contract price and costs rather than estimated contract price and costs. The second step generally
requires the taxpayer to recompute its tax liability for each year of the contract using gross
income as reallocated under the look-back method. If there is any difference between the
recomputed tax liability and the tax liability as previously determined for a year, such difference
is treated as a hypothetical underpayment or overpayment of tax to which the taxpayer applies a
rate of interest equal to the overpayment rate, compounded daily.° The taxpayer receives (or
pays) interest if the net amount of interest applicable to hypothetical overpayments exceeds (or is
less than) the amount of interest applicable to hypothetical underpayments.

The look-back method must be reapplied for any item of income or cost that is properly
taken into account after the completion of the contract.

The look-back method does not apply to any contract that is completed within two
taxable years of the contract commencement date and if the gross contract price does not exceed
the lesser of (1) $1 million or (2) one percent of the average gross receipts of the taxpayer for the
preceding three taxable years. In addition, a simplified look-back method is available to certain
pass-through entities and, pursuant to Treasury regulations, to certain other taxpayers. Under the
simplified look-back method, the hypothetical underpayment or overpayment of tax for a

® The overpayment rate equals the applicable Federal short-term rate plus two percentage
points. This rate is adjusted quarterly by the IRS. Thus, in applying the look-back method for a
contract year, a taxpayer may be required to use five different interest rates

-10-


This right may be waived only by a provision in the will (or revocable trust) specifically referring to
section 2207B.

Description of Proposal

The proposal would provide that the right of recovery with respect to QTIP is waived only to
the extent that language in the decedent's will or revocable trust specifically so indicates. Thus, a
general provision specifying that all taxes be paid by the estate would no longer be sufficient to
waive the right of recovery. The proposal also would provide that the right of contribution for
property over which the decedent retained enjoyment or the right to income is waived by a specific
indication in the decedent's will or revocable trust, but specific reference to section 2207B would no
longer be required.

Effective Date

The proposal would apply to decedents dying after the date of enactment.

3. Transitional rule under section 2056A

Present Law

A "marital deduction" generally is allowed for estate and gift tax purposes for the value of
property passing to a spouse. The Technical and Miscellaneous Revenue Act of 1988 ("TAMRA")
denied the marital deduction for property passing to an alien spouse outside a qualified domestic trust
("QDT"). An estate tax generally is imposed on corpus distributions from a QDT.

TAMRA defined a QDT as a trust that, among other things, required all trustees be U.S.
citizens or domestic corporations. This provision was modified in the Omnibus Budget
Reconciliation Acts of 1989 and 1990 to require that at least one trustee be a U.S. citizen or domestic
corporation and that no corpus distribution be made unless such trustee has the right to withhold any
estate tax imposed on the distribution (the "withholding requirement"). :

Description of Proposal

A trust created before the enactment of the Omnibus Budget Reconciliation Act of 1990
would be treated as satisfying the withholding requirement if its governing instrument requires that
all trustees be U.S. citizens or domestic corporations.

Effective Date

The proposal would apply as if included in the Omnibus Budget Reconciliation Act of 1990.

-52-



Description of Proposal

Under the proposal, an estate and a beneficiary of that estate would be treated as related
persons for purposes of sections 267 and 1239, except in the case of a sale or exchange in satisfaction
of a pecuniary bequest.

Effective Date

The proposal would apply to taxable years beginning after the date of enactment.
11. Limitation on taxable year of estates

Present Law

The taxability of distributions from a trust or estate is based on the amount of income
received by the trust or estate in the trust or estate's taxable year “ending with or within" the taxable
year of the beneficiary (typically a calendar year). Trusts are required to use a calendar year and,
consequently, income of a trust that is distributed to a calendar-year beneficiary in the year earned is
taxed to the beneficiary in the year eamed. Estates, on the other hand, are allowed to use any fiscal
year. Consequently, in the case of estates, the taxation of distributions to a calendar-year beneficiary
in up to the last 11 months of the calendar year can be deferred until the next taxable year depending
upon the fiscal year selected.

Description of Proposal

The proposal would limit the taxable year of an estate to a year ending on October 31,
November 30, or December 31. Thus, the maximum deferral allowed to a calendar-year beneficiary
would be with respect to distributions made in the last two months of the calendar year.

Effective Date

The proposal would apply to decedents dying after the date of enactment.
12. Simplified taxation of earnings of pre-need funeral trusts
Present Law

A pre-need funeral trust is an arrangement where an individual purchases funeral or burial
services or merchandise from a funeral home or cemetery in advance of the individual's death. The
individual enters into a contract with the provider of such services or merchandise whereby the
individual selects the services or merchandise to be provided upon his or her death, and agrees to pay
for them in advance of his or her death. Such amounts (or a portion thereof) are held in trust during
the individual's lifetime and are paid to the seller upon the individual's death,

-58-



The election would apply to all long-term contracts completed during the taxable year for
which the election is made and to all long-term contracts completed during subsequent taxable
years, unless the election is revoked with the consent of the Secretary of the Treasury.

Example 2.--A taxpayer enters into a three-year contract and reports taxable income of
$12,250, $15,000 and $12,750, respectively, for Years 1 through 3 with respect to the contract.
Upon completion of the contract, cumulative look-back income with respect to the contract is
$40,000, and 10 percent of such amount is $4,000. After the completion of the contract, the
taxpayer incurs additional costs of $2,500 in each of the next three succeeding years (Years 4, 5,
and 6) with respect to the contract. Under the bill, an electing taxpayer does not reapply the
look-back method for Year 4 because the cumulative amount of contract taxable income
($37,500) is within 10 percent of contract look-back income as of the completion of the contract
($40,000). However, the look-back method must be applied for Year 5 because the cumulative
amount of contract taxable income ($35,000) is not within 10 percent of contract look-back
income as of the completion of the contract ($40,000). Finally, the taxpayer does not reapply the
look-back method for Year 6 because the cumulative amount of contract taxable income
($32,500) is within 10 percent of contract look-back income as of the last application of the
look-back method ($35,000).

Interest rates used for purposes of the look-back method

The proposal would provide that for purposes of the look-back method, only one rate of
interest is to apply for each accrual period. An accrual period with Tespect to a taxable year
begins on the day after the return due date (determined without regard to extensions) for the
taxable year and ends on such return due date for the following taxable year. The applicable rate
of interest is the overpayment rate in effect for the calendar quarter in which the accrual period
begins.

Effective Date
The proposal would apply to contracts completed in taxable years ending after the date of

enactment. The change in the interest rate calculation also would apply for purposes of the look-
back method applicable to the income forecast method of depreciation.

-12-


B. Other Partnership Audit Rules 2.0.02...

Treatment of partnership items in deficiency proceedings ........
Partnership return to be determinative of audit procedures
to be followed ... 2...

3. Provisions relating to statute of limitations .
4. Expansion of small partnership exception ....
5. Exclusion of partial settlements from 1-year limitation
Om assessment .. 2... cee eee eee eens
6. Extension of time for filing a request for administrative

adjustment 00 c cence cece ee
7. Availability of innocent spouse relief in context of
partnership proceedings ... 20.20.0020. eee eee eee
8. Determination of penalties at partnership level
9. Provisions relating to Tax Court jurisdiction :
10. Treatment of premature petitions filed by notice partners
or S-percent groups... 6... cece eee eens
11. Bonds in case of appeals from certain proceedings
12. Suspension of interest where delay in computational
adjustment resulting from certain settlements .................
13. Special rules for administrative adjustment requests
with respect to bad debts or worthless securities ..............

C. Closing of Partnership Taxable Year With Respect to Deceased
Partner 2.2... eee Dee eee eee eee eee

MODIFICATIONS OF RULES FOR REAL ESTATE
INVESTMENT TRUSTS .... 20.000

REPEAL THE SHORT-SHORT TEST FOR REGULATED
INVESTMENT COMPANIES ...............0.0 00000000 c cece

TAXPAYER PROTECTIONS .......0.0.0.0.0.0.0.0.000000.
A. Provide Reasonable Cause Exception for Additional Penalties ........
B. Clarification of Period for Filing Claims for Refunds ...............

C. Repeal of Authority to Disclose Whether a Prospective Juror Has
Been Audited 2.0.0 e cece ee eveee

33

34

43

44

44

45

46


C. Closing of Partnership Taxable Year With Respect to Deceased Partner
Present Law

The partnership taxable year closes with respect to a partner whose entire interest is sold,
exchanged, or liquidated. Such year, however, generally does not close upon the death of a
partner. Thus, a decedent's entire share of items of income, gain, loss, deduction and credit for
the partnership year in which death occurs is taxed to the estate or successor in interest rather
than to the decedent on his or her final income tax return. See Estate of Hesse v. Commissioner,
74 T.C. 1307, 1311 (1980).

Description of Proposal

The proposal would provide that the taxable year of a partnership closes with respect to a
partner whose entire interest in the partnership terminates, whether by death, liquidation or
otherwise. The proposal would not change present law with respect to the effect upon the
partnership taxable year of a transfer of a partnership interest by a debtor to the debtor's estate
(under Chapters 7 or 11 of Title 11, relating to bankruptcy).

Effective Date

The proposal would apply to partnership taxable years beginning after December 31,
1997,

-33-



4. Tax Court jurisdiction for determination of employment status

Present Law

The Tax Court is a court of limited jurisdiction, established under Article I of the
Constitution. The Tax Court only has the jurisdiction that is expressly conferred on it by statute (sec.
7442).

Description of Proposal

The proposal would provide that, in connection with the audit of any person, if there is an
actual controversy involving a determination by the IRS as part of an examination that (a) one or
more individuals performing services for that person are employees of that person or (b) that person
is not entitled to relief under section 530 of the Revenue Act of 1978, the Tax Court would have
jurisdiction to determine whether the IRS is correct. For example, one way the IRS could make the
required determination is through a mechanism similar to the employment tax early referral
procedures.”

The proposal would provide for de novo review (rather than review of the administrative
record). Assessment and collection of the tax would be suspended while the matter is pending in the
Tax Court. Any determination by the Tax Court would have the force and effect of a decision of the
Tax Court and would be reviewable as such; accordingly, it would be binding on the parties. Awards
of costs and certain fees (pursuant to section 7430) would be available to eligible taxpayers with
respect to Tax Court determinations pursuant to this proposal. The proposal would also provide a
number of procedural rules to incorporate this new jurisdiction within the existing procedures
applicable in the Tax Court.

Effective Date

The proposal would take effect on the date of enactment.

? See Announcement 96-13 and Announcement 97-52.

-75-



Effective Date

Partnership taxable years beginning after December 31, 1997.

5. Treatment of partnership items of individual retirement arrangements

Present Law

Return filing requirements

An individual retirement account ("IRA") is a trust which generally is exempt from
taxation except for the taxes imposed on income from an unrelated trade or business. A
fiduciary of a trust that is exempt from taxation (but subject to the taxes imposed on income from
an unrelated trade or business) generally is required to file a return on behalf of the trust for a
taxable year if the trust has gross income of $1,000 or more included in computing unrelated
business taxable income for that year (Treas. Reg. sec. 1.6012-3(a)(5)).

Unrelated business taxable income is the gross income (including gross income from a
partnership) derived by an exempt organization from an unrelated trade or business, less certain
deductions which are directly connected with the carrying on of such trade or business (sec.
512(a)(1). In calculating unrelated business taxable income, exempt organizations (including
IRAs) generally also are permitted a specific deduction of $1,000 (sec. 512(b)(12)).

Unified audits of partnerships

All but certain small partnerships are subject to unified audit rules established by the Tax
Equity and Fiscal Responsibility Act of 1982. These mules require the tax treatment of all
“partnership items" to’be determined at the partnership, rather than the partner, level.
Partnership items are those items that are more appropriately determined at the partnership level
than at the partner level, including such items as gross income and deductions of the partnership.

Description of Proposal

The proposal would modify the filing threshold for an IRA with an interest ina
partnership that is subject to the partnership-level audit rules. A fiduciary of such an IRA could
treat the trust's share of partnership taxable income as gross income, for purposes of determining
whether the trust meets the $1,000 gross income filing threshold. A fiduciary of an IRA that
receives taxable income from a partnership that is subject to partnership-level audit rules of less
than $1,000 (before the $1,000 specific deduction) would not be required to file an income tax
retum if the IRA does not have any other income from an unrelated trade or business.

Effective Date

Taxable years beginning after December 31, 1997.

-21-



INTRODUCTION

L

Il.

A.

F.

PROVISIONS RELATING TO BUSINESSES GENERALLY
A.

B.

Cc.
PARTNERSHIP SIMPLIFICATION PROVISIONS

A.

CONTENTS

Modifications to Standard Deduction of Dependents; AMT

Treatment of Certain Minor Children. ................0.0...

Increase De Minimis Threshold for Estimated Tax to $1,000 for

Individuals 2. cece eee eee

Optional Methods for Computing SECA Tax Combined .......

Treatment of Certain Reimbursed Expenses of Rural Letter

Carriers’ Vehicles .2 0...

Travel Expenses of Federal Employees Participating in a Federal

Criminal Investigation... 0.6.2... ccc eee ee

Payment of Taxes by Commercially Acceptable Means ........

Modifications to Look-Back Method for Long-Term Contracts . .

Minimum Tax Treatment of Certain Property and Casualty

Insurance Companies ............0 00000000 cece cece ee

Treatment of Construction Allowances Provided to Lessees ...

General Provisions... 2... eee

vue

oes

Treatment of partnership items of individual retirement

arrangements . 0.0... cece eee eee

Simplified flow-through for large partnerships ...........
Simplified audit procedures for electing large partnerships . .
Due date for furnishing information to partners of electing large
partnerships 2.2... eee eee
Partnership returns required on magnetic media ..........

10

10

14

16

16

16
18

20
20

21


B. Clarification of Period for Filing Claims for Refunds
Present Law

The Code contains a series of limitations on tax refunds. Section 6511 of the Code
provides both a limitation on the time period in which a claim for refund can be made (section
6511(a)) and a limitation on the amount that can be allowed as a refund (section 6511(b)).
Section 6511(a) provides the general rule that a claim for refund must be filed within 3 years of
the date of the return or 2 years of the date of payment of the taxes at issue, whichever is later.
Section 6511(b) limits the refund amount that can be covered: if a return was filed, a taxpayer
can recover amounts paid within 2 years before the claim. Section 6512(b)(3) incorporates these
rules where taxpayers who challenge deficiency notices in Tax Court are found to be entitled to
refunds.

In Commissioner v. Lundy, 116 S. Ct. 647 (1996), the taxpayer had not filed a return, but
received a notice of deficiency within 3 years after the date the return was due and challenged
the proposed deficiency in Tax Court. The Supreme Court held that the taxpayer could not
recover overpayments attributable to withholding during the tax year, because no return was
filed and the 2-year “look back” rule applied. Since overwithheld amounts are deemed paid as of
the date the taxpayer’s return was first due (i,e., more than 2 years before the notice of deficiency
was issued), such overpayments could not be recovered. By contrast, if the same taxpayer had
filed a return on the date the notice of deficiency was issued, and then claimed a refund, the 3-
year “look back” rule would apply, and the taxpayer could have obtained a refund of the
overwithheld amounts.

Description of Proposal

The proposal would permit taxpayers who initially fail to file a return, but who receive a
notice of deficiency and file suit to contest it in Tax Court during the third year after the return
due date, to obtain a refund of excessive amounts paid within the 3-year period prior to the date
of the deficiency notice.

Effective Date

The proposal would apply to claims for refund with respect to tax years ending after the
date of enactment.

-45-



8. Determination of penalties at partnership level
Present Law

Partnership items include only items that are required to be taken into account under the
income tax subtitle. Penalties are not partnership items since they are contained in the procedure
and administration subtitle. As a result, penalties may only be asserted against a partner through
the application of the deficiency procedures following the completion of the partnership-level
proceeding.

Description of Proposal

The proposal would provide that the partnership-level proceeding is to include a
determination of the applicability of penalties at the partnership level. However, the proposal
would allow partners to raise any partner-level defenses in a refund forum.

Effective Date
Effective for partnership taxable years ending after the date of enactment.

9. Provisions relating to Tax Court jurisdiction

Present Law

Improper assessment and collection activities by the IRS during the 150-day period for
filing a petition or during the pendency of any Tax Court proceeding, "may be enjoined in the
proper court." Present law may be unclear as to whether this includes the Tax Court.

For a partner other than the Tax Matters Partner to be eligible to file a petition for
redetermination of partnership items in any court or to participate in an existing case, the period
for assessing any tax attributable to the partnership items of that partner must not have expired.
Since such a partner would only be treated as a party to the action if the statute of limitations
with respect to them was still open, the law is unclear whether the partner would have standing
to assert that the statute of limitations had expired with respect to them.

Description of Proposal

The proposal would clarify that an action to enjoin premature assessments of deficiencies
attributable to partnership items may be brought in the Tax Court. The proposal also would
permit a partner to participate in an action or file a petition for the sole purpose of asserting that
the period of limitations for assessing any tax attributable to partnership items has expired for
that person. Additionally, the proposal would clarify that the Tax Court has overpayment
jurisdiction with respect to affected items.

-29-



Treatment of shared appreciation mortgages

For purposes of the income requirements for qualification as a REIT, and for purposes of
the prohibited transaction provisions, any income derived from a "shared appreciation provision"
is treated as gain recognized on the sale of the "secured property." For these purposes, a shared
appreciation provision is any provision that is in connection with an obligation that is held by the
REIT and secured by an interest in real property, which provision entitles the REIT to receive a
specified portion of any gain realized on the sale or exchange of such real property (or of any
gain that would be realized if the property were sold on a specified date). Secured property for
these purposes means the real property that secures the obligation that has the shared
appreciation provision.

In addition, for purposes of the income requirements for qualification as a REIT, and for
purposes of the prohibited transactions provisions, the REIT is treated as holding the secured
property for the period during which it held the shared appreciation provision (or, if shorter, the
period during which the secured property was held by the person holding such property), and the
secured property is treated as property described in section 1221(1) if it is such property in the
hands of the obligor on the obligation to which the shared appreciation provision relates (or if it
would be such property if held by the REIT). For purposes of the prohibited transaction safe
harbor, the REIT is treated as having sold the secured property at the time that it recognizes
income on account of the shared appreciation provision, and any expenditures made by the
holder of the secured property are treated as made by the REIT.

Asset requirements

To satisfy the asset requirements to qualify for treatment as a REIT, at the close of each
quarter of its taxable year, an entity must have at least 75 percent of the value of its assets
invested in real estate assets, cash and cash items, and government securities (sec. 856(c)(5)(A)).
Moreover, not more than 25 percent of the value of the entity's assets can be invested in
securities of any one issuer (other than government securities and other securities described in
the preceding sentence). Further, these securities may not comprise more than five percent of
the entity's assets or more than 10 percent of the outstanding voting securities of such issuer (sec.
856(c)(5)(B)). The term real estate assets is defined to mean real property (including interests in
real property and mortgages on real property) and interests in REITs (sec. 856(c)(6)(B)).

REIT subsidiaries

Under present law, all the assets, liabilities, and items of income, deduction, and credit of
a "qualified REIT subsidiary" are treated as the assets, liabilities, and respective items of the
REIT that owns the stock of the qualified REIT subsidiary. A subsidiary of a REIT is a qualified
REIT subsidiary if and only if 100 percent of the subsidiary's stock is owned by the REIT at all
times that the subsidiary is in existence. If at any time the REIT ceases to own 100 percent of the
stock of the subsidiary, or if the REIT ceases to qualify for (or revokes an election of) REIT
Status, such subsidiary is treated as a new corporation that acquired all of its assets in exchange

-38-


Description of Proposal

The proposal would permit the IRS to apply the TEFRA audit procedures if, based on the
partnership's return for the year, the IRS reasonably determines that those procedures should
apply. Similarly, the proposal, permit the IRS to apply the normal deficiency procedures if,
based on the partnership's return for the year, the IRS reasonably determines that those
procedures should apply.

Effective Date

Partnership taxable years ending after the date of enactment.
3. Provisions relating to statute of limitations

a. Suspend statute when an untimely petition is filed

Present Law

In a deficiency case, section 6503(a) provides that if a proceeding in respect of the
deficiency is placed on the docket of the Tax Court, the period of limitations on assessment and
collection is suspended until the decision of the Tax Court becomes final, and for 60 days
thereafter. The counterpart to this proposal with respect to TEFRA cases is contained in section
6229(d). That section provides that the period of limitations is suspended for the period during
which an action may be brought under section 6226 and, if an action is brought during such
period, until the decision of the court becomes final, and for 1 year thereaf er. As a result of this
difference in language, the running of the statute of limitations in a TEFRA case will only be
tolled by the filing of a timely petition whereas in a deficiency case, the statute of limitations is
tolled by the filing of any petition, regardless of whether the petition is timely.

Description of Proposal

The proposal would conform the suspension rule for the filing of petitions in TEFRA
cases with the rule under section 6503(a) pertaining to deficiency cases. Under the proposal, the
Statute of limitations in TEFRA cases would be suspended by the filing of any petition under
section 6226, regardless of whether the petition is timely or valid, and the suspension would
remain in effect until the decision of the court becomes final, and for one year thereafter. Hence,
if the statute of limitations is open at the time that an untimely petition is filed, the limitations
period would no longer continue to run and possibly expire while the action is pending before
the court.

Effective Date

All cases in which the period of limitations has not expired under present law as of the
date of enactment.

-24-


E. Travel Expenses of Federal Employees Participating
in a Federal Criminal Investigation

Present Law

Unreimbursed ordinary and necessary travel expenses paid or incurred by an individual
in connection with temporary employment away from home (e.g., transportation costs and the
cost of meals and lodging) are generally deductible, subject to the two-percent floor on
miscellaneous itemized deductions. Travel expenses paid or incurred in connection with
indefinite employment away from home, however, are not deductible. A taxpayer's employment
away from home in a single location is indefinite rather than temporary if it lasts for one year or
more; thus, no deduction is permitted for travel expenses paid or incurred in connection with
such employment (sec. 162(a)). If a taxpayer's employment away from home in a single location
lasts for less than one year, whether such employment is temporary or indefinite is determined
on the basis of the facts and circumstances.

Description of Proposal

The one-year limitation with respect to deductibility of expenses while temporarily away
from home would not include any period during which a Federal employee is certified by the
Attorney General (or the Attorney General's designee) as traveling on behalf of the Federal
Government in a temporary duty status to investigate or provide support services to the
investigation of a Federal crime. Thus, expenses for these individuals during these periods
would be fully deductible, regardless of the length of the period for which certification is given
(provided that the other requirements for deductibility are satisfied).

Effective Date

The proposal would be effective for amounts paid or incurred with respect to taxable
years ending after the date of enactment.


includible in gross estate); McNeely v. Commissioner, 16 F.3d 303 (8th Cir. 1994) (transfers from
revocable trust not includible in gross estate); Kisling v. Commissioner, 32 F.3d 1222 (8th Cir. 1994)
(acq.) (transfers from revocable trust not includible in gross estate).

Description of Proposal

The proposal would codify the rule set forth in the McNeely and Kisling cases to provide that
a transfer from a revocable trust (i.e., a trust described under section 676) would be treated as if made
directly by the grantor. Thus, an annual exclusion gift from such a trust would not be included in the
gross estate.

The proposal also would revise section 2035 to improve its clarity.

Effective Date

The proposal would apply to decedents dying after the date of enactment.
14. Clarify relationship between community property rights and retirement benefits
Present Law
community prope

Under state community property laws, each spouse owns an undivided one-half interest in each
community property asset. In community property jurisdictions, a nonparticipant spouse may be treated
as having a vested community property interest in either his or her spouse's qualified plan, individual
retirement arrangement ("IRA"), or simplified employee pension ("SEP") plan.

Transfer tax treatment of qualified plans

In the Retirement Equity Act of 1984 ("REA"), qualified retirement plans were required to
provide automatic survivor benefits (1) in the case of a participant who retires under the plan, in the form
of a qualified joint and survivor annuity, and (2) in the case of a vested participant who dies before the
annuity starting date and who has a surviving spouse, in the form of a preretirement survivor annuity.
A participant generally is permitted to waive such annuities, provided he or she obtains the written
consent of his or her spouse.

The Tax Reform Act of 1986 repealed the estate tax exclusion, formerly contained in sections
2039(c) and 2039(d), for certain interests in qualified plans owned by a nonparticipant spouse attributable
to community property laws and made certain other changes to conform the transfer tax treatment of
qualified and nonqualified plans.

-60-



F. Other Provisions

1. Due date for first quarter estimated tax payments by private foundations

Present Law

Under section 4940, tax-exempt private foundations generally are required to pay an excise
tax equal to two percent of their net investment income for the taxable year. Under section
6655(g)(3), private foundations are required to pay estimated tax with respect to their excise tax
liability under section 4940 (as well as any unrelated business income tax (UBIT) liability under
section 511).¥ Section 6655(c) provides that this estimated tax is payable in quarterly instaliments
and that, for calendar-year foundations, the first quarterly installment is due on April 15th. Under
section 6655(i), foundations with taxable years other than the calendar year must make their quarterly
estimated tax payments no later than the dates in their fiscal years that correspond to the dates
applicable to calendar-year foundations.

Description of Proposal

The proposal would amend Code section 6655(g)(3) to provide that a calendar-year
foundation's first-quarter estimated tax payment is due on May 15th (which is the same day that its
annual return, Form 990-PF, for the preceding year is due). As a result of the operation of
present-law section 6655(i), fiscal-year foundations would be required to make their first-quarter
estimated tax payment no later than the 15th day of the fifth month of their taxable year.

Effective Date
The provision would apply to taxable years beginning after the date of enactment.

2. Withholding of Puerto Rico income taxes from the wages of Federal employees

Present Law

If State law provides generally for the withholding of State income taxes from the wages of
employees in a State, the Secretary of the Treasury shall (upon the request of the State) enter into an
agreement with the State providing for the withholding of State income taxes from the wages of
Federal employees in the State. For this purpose, a State is a State, territory, or possession of the
United States. The Court of Appeals for the Federal Circuit recently held in Romero v. United States
(38 F. 3d 1204 (1994)) that Puerto Rico was not encompassed within this definition, consequently,

* Generally, the amount of the first quarter payment must be at least 25 percent of the
lesser of (1) the preceding year's tax liability, as shown on the fotindation's Form 990-PF, or (2)
95 percent of the foundation's current-year tax liability.

-76-



C. Repeal of Authority to Disclose Whether a Prospective Juror Has Been Audited
Present Law

In connection with a civil or criminal tax proceeding to which the United States is a
party, the Secretary must disclose, upon the written request of either party to the lawsuit, whether
an individual who is a prospective juror has or has not been the subject of an audit or other tax
investigation by the Internal Revenue Service (sec. 6103(h)(5)).

This disclosure requirement, as it has been interpreted by several recent court decisions,
has created significant difficulties in the civil and criminal tax litigation process. First, the
litigation process can be substantially slowed. It can take the Secretary a considerable period of
time to compile the information necessary for a response (some courts have required searches
going back as far as 25 years). Second, providing early release of the list of potential jurors to
defendants (which several recent court decisions have required to permit defendants to obtain
disclosure of the information from the Secretary) can provide an opportunity for harassment and
intimidation of potential jurors in organized crime, drug, and some tax protester cases. Third,
significant judicial resources have been expended in interpreting this procedural requirement that
might better be spent resolving substantive disputes. Fourth, differing judicial interpretations of
this provision have caused confusion. In some instances, defendants convicted of criminal tax
offenses have obtained reversals of those convictions because of failures to comply fully with
this provision.

Description of Proposal

The proposal would repeal the requirement that the Secretary disclose, upon the written
request of either party to the lawsuit, whether an individual who is a prospective juror has or has
not been the subject of an audit or other tax investigation by the Internal Revenue Service.

Effective Date

: The proposal would be effective for judicial proceedings commenced after the date of
enactment.

~46-



E. Awarding of Administrative Costs and Attorneys Fees

Present Law

Any person who substantially prevails in any action brought by or against the United
States in connection with the determination, collection, or refund of any tax, interest, or penalty
may be awarded reasonable administrative costs incurred before the IRS and reasonable
litigation costs incurred in connection with any court proceeding.

No time limit is specified for the taxpayer to apply to the IRS for an award of
administrative costs. In addition, no time limit is specified for a taxpayer to appeal to the Tax
Court an IRS decision denying an award of administrative costs. Finally, the procedural rules for
adjudicating a denial of administrative costs are unclear.

Description of Proposal

The proposal would provide that a taxpayer who seeks an award of administrative costs
must apply for such costs within 90 days of the date on which the taxpayer was determined to be
a prevailing party. The proposal also would provide that a taxpayer who seeks to appeal an IRS
denial of an administrative cost award must petition the Tax Court within 90 days after the date
that the IRS mails the denial notice.

The proposal would clarify that dispositions by the Tax Court of petitions relating only to
administrative costs are to be reviewed in the same manner as other decisions of the Tax Court.

Effective Date

The proposal would be effective with respect to costs incurred in civil actions or
proceedings commenced after the date of enactment.

-48-



contract year generally is determined by applying the highest rate of tax applicable to such
taxpayer to the change in gross income as recomputed under the look-back method.

Description of Proposal
Election not to apply the look-back method for de minimis amounts

The proposal would provide that a taxpayer may elect not to apply the look-back method
with respect to a long-term contract if for each prior contract year, the cumulative taxable
income (or loss) under the contract as determined using estimated contract price and costs is
within 10 percent of the cumulative taxable income (or loss) as determined using actual contract
price and costs.

Thus, under the election, upon completion of a long-term contract, a taxpayer would be
required to apply the first step of the look-back method (the reallocation of gross income using
actual, rather than estimated, contract price and costs), but would not be required to apply the
additional steps of the look-back method if the application of the first step resulted in de minimis
changes to the amount of income previously taken into account for each prior contract year.

The election would apply to all long-term contracts completed during the taxable year for
which the election is made and to all long-term contracts completed during subsequent taxable
years, unless the election is revoked with the consent of the Secretary of the Treasury.

Example 1.--A taxpayer enters into a three-year contract and upon completion of the
contract, determines that annual net income under the contract using actual contract price and
costs is $100,000, $150,000, and $250,000, respectively, for Years 1, 2, and 3 under the
percentage of completion method. An electing taxpayer need not apply the look-back method to
the contract if it had reported cumulative net taxable income under the contract using estimated
contract price and costs of between $90,000 and $110,000 as of the end of Year 1; and between
$225,000 and $275,000 as of the end of Year 2.

Election not to reapply the look-back method

The proposal would provide that a taxpayer may elect not to reapply the look-back
method with respect to a contract if, as of the close of any taxable year after the year the contract
is completed, the cumulative taxable income (or loss) under the contract is within 10 percent of
the cumulative look-back income (or loss) as of the close of the most recent year in which the
look-back method was applied (or would have applied but for the other de minimis exception
described above). In applying this rule, amounts that are taken into account after completion of
the contract would not be discounted.

Thus, an electing taxpayer need not apply or reapply the look-back method if amounts
that are taken into account after the completion of the contract are de minimis.

-ll-